Tableof Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**Form 10-Q**

 

**x****      QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**Forthe quarterly period ended September 30, 2009**

** **

**OR**

** **

**o****         TRANSITION REPORT UNDERSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**Commissionfile number 001-34142**

 

**OAK VALLEY BANCORP**

(Exact name ofregistrant as specified in its charter)

 

| **California**                  | ** ** | **26-2326676**      |
|---------------------------------|------------|---------------------|
| State or other  jurisdiction of |       | I.R.S. Employer     |
| incorporation or  organization  |       | Identification  No. |

 

**125N. Third Ave., Oakdale, CA  95361**

(Address ofprincipal executive offices)

 

**(209)848-2265**

Issuer’s telephonenumber

 

**Notapplicable**

(Former name,former address and former fiscal year, if changed since last report)

 

Indicate by check markwhether the issuer (1) has filed all reports required to be filed by Section 13or 15(d) of the Exchange Act during the past 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by checkmark whether the registrant has submitted electronically and posted on itscorporate web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files). Yes o No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

 

| Large  accelerated filer o                |   | Accelerated  filer o         |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated  filer o                  |   | Smaller  reporting company x |
| (Do not check if  a smaller reporting company) |   |                              |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes o No x

 

**APPLICABLEONLY TO CORPORATE ISSUERS**

 

State the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date:  7,681,877shares of common stock outstanding as of October 30, 2009.

 

 

 

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Table of Contents

 

**OakValley Bancorp**

**September 30,2009**

 

**Index**

 
| ** **                                                                                                                                                                     | ** **                                                                                      | **Page** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|----------|
| **PART I –  FINANCIAL INFORMATION**                                                                                                                                  | 3                                                                                               |
|                                                                                                                                                                           |                                                                                            |
| **Item 1.**                                                                                                                                                                    | **Financial Statements**                                                                        | 3        |
|                                                                                                                                                                           |                                                                                            |     |
| Condensed  Consolidated Balance Sheets at September 30, 2009, and December 31,  2008                                                                                 | 4                                                                                               |
|                                                                                                                                                                           |                                                                                            |     |
| Condensed Consolidated  Statements of Operations for the Three and Nine Month Periods Ended  September 30, 2009 and September 30, 2008                               | 5                                                                                               |
|                                                                                                                                                                           |                                                                                            |     |
| Condensed  Consolidated Statements of Changes of Shareholders’ Equity for the Nine-Month  Period Ended September 30, 2009 and the Year Ended December 31,  2008 | 6                                                                                               |
|                                                                                                                                                                           |                                                                                            |     |
| Condensed  Consolidated Statements of Cash Flows for the Nine-Month Periods Ended  September 30, 2009 and September 30, 2008                                         | 7                                                                                               |
|                                                                                                                                                                           |                                                                                            |     |
| Notes to Consolidated Financial Statements                                                                                                                                     | 8                                                                                               |
|                                                                                                                                                                           |                                                                                            |     |
| **Item 2.**                                                                                                                                                                    | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** | 17       |
| ** **                                                                                                                                                                     | ** **                                                                                      |     |
| **Item 3.**                                                                                                                                                                    | **Quantitative  and Qualitative Disclosures About Market Risk**                                 | 31       |
| ** **                                                                                                                                                                     | ** **                                                                                      |     |
| **Item 4T.**                                                                                                                                                                   | **Controls and Procedures**                                                                     | 31       |
|                                                                                                                                                                           |                                                                                            |     |
| **PART II  – OTHER INFORMATION**                                                                                                                                     | 32                                                                                              |
|                                                                                                                                                                           |                                                                                            |     |
| **Item 1.**                                                                                                                                                                    | **Legal Proceedings**                                                                           | 32       |
| **Item 2.**                                                                                                                                                                    | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                | 32       |
| **Item 3.**                                                                                                                                                                    | **Defaults  Upon Senior Securities**                                                            | 32       |
| **Item 4.**                                                                                                                                                                    | **Submission  of Matters to a Vote of Security Holders**                                        | 32       |
| **Item 5.**                                                                                                                                                                    | **Other Information**                                                                           | 32       |
| **Item 6.**                                                                                                                                                                    | **Exhibits**                                                                                    | 32       |

 

2

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**PART I – FINANCIAL STATEMENTS**

 

**Item 1.Financial Statements**

 

3

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**OAKVALLEY BANCORP**

**CONDENSEDCONSOLIDATED BALANCE SHEETS (UNAUDITED)**

**ATSEPTEMBER 30, 2009 AND DECEMBER 31, 2008**

** **
| ** **                                                                                                                                                                                  | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|-------------|-----------------------|------------|
| ** **                                                                                                                                                                                  | ** ** | **2009**               | ** **  | **2008**              | ** ** |
| **ASSETS**                                                                                                                                                                                  |       |                   |        |                  |       |
| Cash  and due from banks                                                                                                                                                                    |       | $                      | 9,601,446   |                  | $          | 9,072,860 |   |
| Federal  funds sold                                                                                                                                                                         |       | 5,490,000              |        | 765,000               |       |
| Cash  and cash equivalents                                                                                                                                                                  |       | 15,091,446             |        | 9,837,860             |       |
|                                                                                                                                                                                        |       |                   |        |                  |       |
| Securities  available for sale                                                                                                                                                              |       | 53,564,662             |        | 41,448,877            |       |
| Loans,  net of allowance for loan loss of $6,396,367 in 2009 and $5,569,496 in 2008                                                                                                         |       | 418,122,087            |        | 421,572,911           |       |
| Bank  premises and equipment, net                                                                                                                                                           |       | 10,370,313             |        | 11,093,967            |       |
| Other  real estate owned (“OREO”)                                                                                                                                                 |       | 1,990,782              |        | 2,745,575             |       |
| Accrued  interest and other assets                                                                                                                                                          |       | 22,039,878             |        | 21,503,821            |       |
|                                                                                                                                                                                        |       |                   |        |                  |       |
|                                                                                                                                                                                        |       | $                      | 521,179,168 |                  | $          | 508,203,011 |   |
|                                                                                                                                                                                        |       |                   |        |                  |       |
| **LIABILITIES AND  SHAREHOLDERS’ EQUITY**                                                                                                                                              | ** ** | ** **             | ** **  | ** **            | ** ** |
|                                                                                                                                                                                        |       |                   |        |                  |       |
| Deposits                                                                                                                                                                                    |       | $                      | 431,532,833 |                  | $          | 378,248,467 |   |
| Accrued  interest and other liabilities                                                                                                                                                     |       | 2,582,878              |        | 2,968,465             |       |
| FHLB  advances                                                                                                                                                                              |       | 27,000,000             |        | 69,000,000            |       |
|                                                                                                                                                                                        |       |                   |        |                  |       |
| Total  liabilities                                                                                                                                                                          |       | 461,115,711            |        | 450,216,932           |       |
|                                                                                                                                                                                        |       |                   |        |                  |       |
| Shareholders’  equity                                                                                                                                                                  |       |                   |        |                  |       |
| Preferred stock, no par  value; $1,000 per share liquidation preference, 10,000 shares authorized and  13,500 issued and outstanding at September 30, 2009 and  December 31, 2009 |       | 12,805,635             |        | 12,680,649            |       |
| Common stock, no par  value; 10,000,000 shares authorized and 7,681,877 and 7,661,627 shares issued  and outstanding at September 30, 2009 and December 31, 2008,  respectively   |       | 23,933,441             |        | 23,863,331            |       |
| Additional  paid-in capital                                                                                                                                                                 |       | 1,981,624              |        | 1,925,224             |       |
| Retained  earnings                                                                                                                                                                          |       | 19,705,766             |        | 19,226,645            |       |
| Accumulated  other comprehensive income, net of tax                                                                                                                                         |       | 1,636,991              |        | 290,230               |       |
|                                                                                                                                                                                        |       |                   |        |                  |       |
| Total  shareholders’ equity                                                                                                                                                            |       | 60,063,457             |        | 57,986,079            |       |
|                                                                                                                                                                                        |       |                   |        |                  |       |
|                                                                                                                                                                                        |       | $                      | 521,179,168 |                  | $          | 508,203,011 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements.*

 

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**OAKVALLEY BANCORP**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

**FOR THETHREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2009 AND SEPTEMBER 30, 2008**

** **
| ** **                                             | ** ** | **THREE MONTHS ENDED** | ** ** | **NINE MONTHS ENDED** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                             | ** ** | **SEPTEMBER 30,**      | ** ** | **SEPTEMBER 30,**     | ** ** |
| ** **                                             | ** ** | **2009**               | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
| Interest  and fees on loans                            |       | $                      | 6,736,602  |                  | $          | 7,040,391 |   | $ | 20,048,818 |   | $ | 20,750,394 |   |
| Interest  on securities available for sale             |       | 678,379                |       | 403,064               |       | 1,967,059 |   | 1,205,973 |   |
| Interest  on federal funds sold                        |       | 1,334                  |       | 4,254                 |       | 2,929 |   | 13,831 |   |
| Interest  on deposits with banks                       |       | 1,942                  |       | 566                   |       | 3,574 |   | 1,592 |   |
| Total  interest income                                 |       | 7,418,257              |       | 7,448,275             |       | 22,022,380 |   | 21,971,790 |   |
|                                                   |       |                   |       |                  |       |   |   |   |   |
| Deposits                                               |       | 1,245,576              |       | 1,700,868             |       | 3,918,842 |   | 5,568,872 |   |
| FHLB  advances                                         |       | 152,841                |       | 455,441               |       | 539,979 |   | 1,214,339 |   |
| Federal  funds purchased                               |       | 38                     |       | 238                   |       | 381 |   | 7,554 |   |
| Total  interest expense                                |       | 1,398,455              |       | 2,156,547             |       | 4,459,202 |   | 6,790,765 |   |
|                                                   |       |                   |       |                  |       |   |   |   |   |
| Net  interest income                                   |       | 6,019,802              |       | 5,291,728             |       | 17,563,178 |   | 15,181,025 |   |
|                                                   |       |                   |       |                  |       |   |   |   |   |
| Provision  for loan losses                             |       | 925,000                |       | 602,000               |       | 4,962,012 |   | 1,187,000 |   |
|                                                   |       |                   |       |                  |       |   |   |   |   |
| Net interest income  after provision for loan losses   |       | 5,094,802              |       | 4,689,728             |       | 12,601,166 |   | 13,994,025 |   |
|                                                   |       |                   |       |                  |       |   |   |   |   |
| Service  charges on deposits                           |       | 300,282                |       | 337,264               |       | 875,229 |   | 984,556 |   |
| Earnings on cash  surrender value of life insurance    |       | 101,057                |       | 99,241                |       | 303,170 |   | 279,759 |   |
| Mortgage  commissions                                  |       | 38,143                 |       | 23,410                |       | 127,160 |   | 94,859 |   |
| Other  income                                          |       | 338,154                |       | 174,557               |       | 717,763 |   | 561,250 |   |
| Total  non-interest income                             |       | 777,636                |       | 634,472               |       | 2,023,322 |   | 1,920,424 |   |
|                                                   |       |                   |       |                  |       |   |   |   |   |
| Salaries  and employee benefits                        |       | 1,974,022              |       | 2,319,467             |       | 5,889,247 |   | 7,200,869 |   |
| Occupancy  expenses                                    |       | 658,928                |       | 675,728               |       | 2,031,844 |   | 2,015,674 |   |
| Data  processing fees                                  |       | 220,181                |       | 193,009               |       | 672,597 |   | 562,007 |   |
| OREO  expenses                                         |       | 915,623                |       | 485,292               |       | 1,974,375 |   | 936,370 |   |
| Assessments  (FDIC & DFI)                     |       | 230,269                |       | 87,160                |       | 667,355 |   | 259,056 |   |
| Other  operating expenses                              |       | 745,563                |       | 774,553               |       | 2,234,073 |   | 2,179,393 |   |
| Total  non-interest expense                            |       | 4,744,586              |       | 4,535,209             |       | 13,469,491 |   | 13,153,369 |   |
|                                                   |       |                   |       |                  |       |   |   |   |   |
| Net  income before provision (benefit) forincome taxes |       | 1,127,852              |       | 788,991               |       | 1,154,997 |   | 2,761,080 |   |
|                                                   |       |                   |       |                  |       |   |   |   |   |
| Provision  (benefit) for income taxes                  |       | 248,701                |       | 239,595               |       | (109,401 | ) | 883,150 |   |
|                                                   |       |                   |       |                  |       |   |   |   |   |
| Net  income                                            |       | $                      | 879,151    |                  | $          | 549,396 |   | $ | 1,264,398 |   | $ | 1,877,930 |   |
|                                                   |       |                   |       |                  |       |   |   |   |   |
| Preferred  stock dividends and accretion               |       | 210,411                |       | 0                     |       | 631,233 |   | 0 |   |
| Net  income available to common shareholders           |       | $                      | 668,740    |                  | $          | 549,396 |   | $ | 633,165 |   | $ | 1,877,930 |   |
|                                                   |       |                   |       |                  |       |   |   |   |   |
| Net  income per common share                           |       | $                      | 0.09       |                  | $          | 0.07 |   | $ | 0.08 |   | $ | 0.25 |   |
| Net  income per common diluted share                   |       | $                      | 0.09       |                  | $          | 0.07 |   | $ | 0.08 |   | $ | 0.24 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements*

 

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**OAKVALLEY BANCORP**

**CONDENSEDCONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)**

**FOR THEYEAR ENDED DECEMBER 31, 2008 AND THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2009**

 
| ** **                                                                                        | ** ** | **YEAR ENDED DECEMBER 31, 2008  AND THE NINE MONTH PERIOD ENDED SEPTEMBER 30, 2009** |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|
| ** **                                                                                        | ** ** | ** **                                                                           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                                                                                        | ** ** | ** **                                                                           | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** ** | ** ** | ** ** | ** ** | **Other** | ** ** | **Total** | ** ** |
| ** **                                                                                        | ** ** | **Common Stock**                                                                     | ** ** | **Preferred** | ** ** | **Paid-in** | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | **Comprehensive** | ** ** | **Shareholders’** | ** ** |
| ** **                                                                                        | ** ** | **Shares**                                                                           | ** ** | **Amount** | ** ** | **Stock** | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Income** | ** ** | **Income** | ** ** | **Equity** | ** ** |
| Balances, January 1, 2008                                                                    |       | 7,607,780                                                                            |   | $ | 22,843,171 |   |   |   | $ | 1,748,380 |   | $ | 17,723,646 |   |   |   | $ | 46,193 |   | $ | 42,361,390 |   |
| Stock options exercised                                                                           |       | 53,847                                                                               |   | 186,922 |   |   |   |   |   |   |   |   |   |   |   | 186,922 |   |
| Issuance of preferred stock                                                                       |       |                                                                                 |   |   |   | $ | 12,666,762 |   |   |   |   |   |   |   |   |   | 12,666,762 |   |
| Issuance of TCPP warrants                                                                         |       |                                                                                 |   | 833,238 |   |   |   |   |   |   |   |   |   |   |   | 833,238 |   |
| Preferred stock accretion                                                                         |       |                                                                                 |   |   |   | 13,887 |   |   |   | (13,887 | ) |   |   |   |   | 0 |   |
| Tax benefit of stock options exercised                                                            |       |                                                                                 |   |   |   |   |   | 54,195 |   |   |   |   |   |   |   | 54,195 |   |
| Cash dividends ($0.075 per share)                                                                 |       |                                                                                 |   |   |   |   |   |   |   | (574,484 | ) |   |   |   |   | (574,484 | ) |
| Stock based compensation                                                                          |       |                                                                                 |   |   |   |   |   | 122,649 |   |   |   |   |   |   |   | 122,649 |   |
| Cumulative effect of adopting EITF 06-04                                                          |       |                                                                                 |   |   |   |   |   |   |   | (70,459 | ) |   |   |   |   | (70,459 | ) |
| Comprehensive income                                                                              |       |                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net  changes in unrealized gain on available-for-sale securities (net of income  tax of $158,664) |       |                                                                                 |   |   |   |   |   |   |   |   |   | 244,037 |   | 244,037 |   | 244,037 |   |
| Net income                                                                                        |       |                                                                                 |   |   |   |   |   |   |   | 2,161,829 |   | 2,161,829 |   |   |   | 2,161,829 |   |
| Comprehensive income                                                                              |       |                                                                                 |   |   |   |   |   |   |   |   |   | $ | 2,405,866 |   |   |   |   |   |
| Balances, December 31, 2008                                                                  |       | 7,661,627                                                                            |   | $ | 23,863,331 |   | $ | 12,680,649 |   | $ | 1,925,224 |   | $ | 19,226,645 |   |   |   | $ | 290,230 |   | $ | 57,986,079 |   |
| Stock options exercised                                                                           |       | 20,250                                                                               |   | $ | 70,110 |   |   |   |   |   |   |   |   |   |   |   | 70,110 |   |
| Preferred stock accretion                                                                         |       |                                                                                 |   |   |   | $ | 124,986 |   |   |   | $ | (124,986 | ) |   |   |   |   | 0 |   |
| Preferred stock dividend payments                                                                 |       |                                                                                 |   |   |   |   |   |   |   | (468,750 | ) |   |   |   |   | (468,750 | ) |
| Cash dividends ($0.025 per share)                                                                 |       |                                                                                 |   |   |   |   |   |   |   | (191,541 | ) |   |   |   |   | (191,541 | ) |
| Stock based compensation                                                                          |       |                                                                                 |   |   |   |   |   | $ | 56,400 |   |   |   |   |   |   |   | 56,400 |   |
| Comprehensive income                                                                              |       |                                                                                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net  changes in unrealized gain on available-for-sale securities (net of income  tax of $955,957) |       |                                                                                 |   |   |   |   |   |   |   |   |   | 1,346,761 |   | 1,346,761 |   | 1,346,761 |   |
| Net income                                                                                        |       |                                                                                 |   |   |   |   |   |   |   | 1,264,398 |   | 1,264,398 |   |   |   | 1,264,398 |   |
| Comprehensive income                                                                              |       |                                                                                 |   |   |   |   |   |   |   |   |   | $ | 2,611,159 |   |   |   |   |   |
| Balances, September 30, 2009                                                                 |       | 7,681,877                                                                            |   | $ | 23,933,441 |   | $ | 12,805,635 |   | $ | 1,981,624 |   | $ | 19,705,766 |   |   |   | $ | 1,636,991 |   | $ | 60,063,457 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements*

 

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**OAKVALLEY BANCORP**

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS (UNAUDITED)**

**FOR THENINE-MONTH PERIODS ENDED SEPTEMBER 30, 2009 AND SEPTEMBER 30, 2008**

** **
| ** **                                                                                | ** ** | **NINE MONTHS ENDED  SEPTEMBER 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                | ** ** | **2009**                             | ** ** | **2008** | ** ** |
|                                                                                      |       |                                 |       |   |   |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                                    |       |                                 |       |   |   |
| Net income                                                                                |       | $                                    | 1,264,398  |   | $ | 1,877,930 |   |
| Adjustments to reconcile  net earnings to net cash from operating activities:             |       |                                 |       |   |   |
| Provision for loan losses                                                                 |       | 4,962,012                            |       | 1,187,000 |   |
| Depreciation,  amortization and accretion, net                                            |       | 775,748                              |       | 835,826 |   |
| Stock-based compensation  expense                                                         |       | 56,400                               |       | 101,498 |   |
| Excess tax benefits from  stock-based payment arrangements                                |       | 0                                    |       | (54,195 | ) |
| Gain on sale of premises  and equipment                                                   |       | 0                                    |       | (2,428 | ) |
| OREO Write downs and  losses on sale                                                      |       | 1,974,375                            |       | 936,370 |   |
| Gain on called available  for sale securities                                             |       | (132,192                             | )          | 0 |   |
| Decrease in accrued  interest payable and other liabilities                               |       | (385,587                             | )          | (939,301 | ) |
| Decrease in accrued  interest receivable                                                  |       | 113,663                              |       | 100,599 |   |
| Increase in other assets                                                                  |       | (1,848,463                           | )          | (2,835,696 | ) |
| Net cash from operating  activities                                                       |       | 6,780,354                            |       | 1,207,603 |   |
|                                                                                      |       |                                 |       |   |   |
| CASH FLOWS FROM INVESTING  ACTIVITIES:                                                    |       |                                 |       |   |   |
| Purchases of available  for sale securities                                               |       | (16,925,358                          | )          | (6,459,330 | ) |
| Proceeds from maturities, calls, and principal paydowns  of securities available for sale |       | 7,275,261                            |       | 6,995,919 |   |
| Net increase in loans                                                                     |       | (2,697,451                           | )          | (34,320,111 | ) |
| Purchase of BOLI policies                                                                 |       | 0                                    |       | (4,740,000 | ) |
| Proceeds from sale of  OREO                                                               |       | 209,467                              |       | 0 |   |
| Proceeds from sales of  premises and equipment                                            |       | 0                                    |       | 47,778 |   |
| Net purchases of premises  and equipment                                                  |       | (82,872                              | )          | (1,025,346 | ) |
| Net cash used in  investing activities                                                    |       | (12,220,953                          | )          | (39,501,090 | ) |
|                                                                                      |       |                                 |       |   |   |
| CASH FLOWS FROM FINANCING  ACTIVITIES:                                                    |       |                                 |       |   |   |
| FHLB advanced funds                                                                       |       | 50,700,000                           |       | 205,463,000 |   |
| FHLB payments                                                                             |       | (92,700,000                          | )          | (158,463,000 | ) |
| Federal funds advances                                                                    |       | 8,770,000                            |       | 63,175,000 |   |
| Federal funds payments                                                                    |       | (8,770,000                           | )          | (63,175,000 | ) |
| Shareholder cash  dividends paid                                                          |       | (191,541                             | )          | (382,943 | ) |
| Preferred stock dividend  payment                                                         |       | (468,750                             | )          | 0 |   |
| Net increase in demand  deposits and savings accounts                                     |       | 48,137,511                           |       | 6,249,207 |   |
| Net increase (decrease)  in time deposits                                                 |       | 5,146,855                            |       | (18,367,424 | ) |
| Excess tax benefits from  stock-based payment arrangements                                |       | 0                                    |       | 54,195 |   |
| Proceeds from sale of  common stock and exercise of stock options                         |       | 70,110                               |       | 176,047 |   |
| Net cash from financing  activities                                                       |       | 10,694,185                           |       | 34,729,082 |   |
|                                                                                      |       |                                 |       |   |   |
| NET INCREASE (DECREASE)  IN CASH AND CASH EQUIVALENTS                                     |       | 5,253,586                            |       | (3,564,405 | ) |
|                                                                                      |       |                                 |       |   |   |
| CASH AND CASH  EQUIVALENTS, beginning of period                                           |       | 9,837,860                            |       | 14,202,951 |   |
|                                                                                      |       |                                 |       |   |   |
| CASH AND CASH  EQUIVALENTS, end of period                                                 |       | $                                    | 15,091,446 |   | $ | 10,638,546 |   |
|                                                                                      |       |                                 |       |   |   |
| SUPPLEMENTAL DISCLOSURES  OF CASH FLOW INFORMATION:                                       |       |                                 |       |   |   |
| Cash paid during the year  for:                                                           |       |                                 |       |   |   |
| Interest                                                                                  |       | $                                    | 4,766,247  |   | $ | 7,860,601 |   |
| Income taxes                                                                              |       | $                                    | 1,014,000  |   | $ | 890,000 |   |
|                                                                                      |       |                                 |       |   |   |
| NON-CASH INVESTING  ACTIVITIES:                                                           |       |                                 |       |   |   |
| Real estate acquired  through foreclosure                                                 |       | $                                    | 1,186,263  |   | $ | 4,364,693 |   |
| Change in unrealized gain/loss on available-for-sale  securities                          |       | $                                    | 2,302,718  |   | $ | 55,724 |   |
|                                                                                      |       |                                 |       |   |   |
| NON-CASH FINANCING  ACTIVITIES:                                                           |       |                                 |       |   |   |
| Tax benefit from stock  options exercised                                                 |       | $                                    | 0          |   | $ | 54,195 |   |
| Cumulative effect of  adopting EITF 06-04                                                 |       | $                                    | 0          |   | $ | 119,842 |   |
| Accretion of preferred  stock                                                             |       | $                                    | 124,986    |   | $ | 0 |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements.*

 

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**OAKVALLEY BANCORP**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

 

**NOTE 1 –BASIS OF PRESENTATION**

 

On July 3, 2008 (the“Effective Date”), a bank holding company reorganization was completed wherebyOak Valley Bancorp became the parent holding company for Oak Valley CommunityBank ( the “Bank”).  On the Effective Date, each outstanding share ofthe Bank was converted into one share of Oak Valley Bancorp and the Bank becamea wholly-owned subsidiary of the holding company. The condensed consolidatedfinancial statements and accompanying footnotes are presented as if thereorganization occurred as of the earliest periods presented and are consistentwith those of Oak Valley Community Bank, since prior to the Effective Date, OakValley Bancorp had no material assets, liabilities or operations.

 

The accounting principlesfollowed by the Company and the methods of applying these principles conformwith accounting principles generally accepted in the United States of America(GAAP) and with general practices within the banking industry. In preparingfinancial statements in conformity with GAAP, management is required to makeestimates and assumptions that affect the reported amounts in the financialstatements. Actual results could differ significantly from those estimates.Material estimates common to the banking industry that are particularly susceptibleto significant change in the near term include, but are not limited to, thedetermination of the allowance for loan losses, the estimation of compensationexpense related to stock options granted to employees and directors, andvaluation allowances associated with deferred tax assets, the recognition ofwhich are based on future taxable income.

 

Management has evaluatedsubsequent events for potential recognition and/or disclosure through theissuance date of this Form 10-Q, and has determined that there were nosubsequent events that require recognition or disclosure.

 

The interim consolidatedfinancial statements included in this report are unaudited but reflect alladjustments which, in the opinion of management, are necessary for a fairpresentation of the financial position and results of operations for theinterim periods presented. All such adjustments are of a normal recurringnature. The results of operations for the three and nine month periods ended September 30,2009 are not necessarily indicative of the results of a full year’soperations.  For further information,refer to the audited financial statements and footnotes included in the Company’sForm 10-K for the year ended December 31, 2008.

 

**NOTE 2 –CURRENT ACCOUNTING PRONOUNCEMENTS**

 

*AccountingStandards Codification*. The Financial Accounting StandardsBoard’s (FASB) Accounting Standards Codification (ASC) became effective on July 1,2009. At that date, the ASC became FASB’s officially recognized source ofauthoritative U.S. generally accepted accounting principles (GAAP) applicableto all public and non-public non-governmental entities, superseding existingFASB, American Institute of Certified Public Accountants (AICPA), EmergingIssues Task Force (EITF) and related literature. Rules and interpretivereleases of the SEC under the authority of federal securities laws are alsosources of authoritative GAAP for SEC registrants. All other accountingliterature is considered non-authoritative. The switch to the ASC affects theaway companies refer to U.S. GAAP in financial statements and accountingpolicies. Citing particular content in the ASC involves specifying the uniquenumeric path to the content through the Topic, Subtopic, Section andParagraph structure.

 

*FASB ASC Topic 815,“Derivatives and Hedging.”* New authoritative accountingguidance under ASC Topic 815, “Derivatives and Hedging,” amends prior guidanceto amend and expand the disclosure requirements for derivatives and hedgingactivities to provide greater transparency about (i) how and why an entityuses derivative instruments, (ii) how derivative instruments and relatedhedge items are accounted for under ASC Topic 815, and (iii) howderivative instruments and related hedged items affect an entity’s financialposition, results of operations and cash flows. To meet those objectives, thenew authoritative accounting guidance requires qualitative disclosures aboutobjectives and strategies for using derivatives, quantitative disclosures aboutfair value amounts of gains and losses on derivative instruments anddisclosures about credit-risk-related contingent features in derivativeagreements. The new authoritative accounting guidance under ASC Topic 815became effective for the Company on January 1, 2009 and did not have asignificant impact on the Company’s financial statements.

 

*FASB ASC Topic 820,“Fair Value Measurements and Disclosures.”*New authoritativeaccounting guidance under ASC Topic 820,”Fair Value Measurements andDisclosures,” affirms that the objective of fair value when the market for anasset is not active is the price that would be received to sell the asset in anorderly transaction, and clarifies and includes additional factors fordetermining whether there has been a significant decrease in market activityfor an asset when the market for that asset is not active. ASC Topic 820requires an entity to base its conclusion about whether a transaction was notorderly on the weight of the evidence. The new accounting guidance amendedprior guidance to expand certain disclosure requirements. The Company adoptedthe new authoritative accounting guidance under ASC Topic 820 during the firstquarter of 2009. Adoption of the new guidance did not significantly impact theCompany’s financial statements.

 

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Further new authoritative accounting guidance(Accounting Standards Update No. 2009-5) under ASC Topic 820 providesguidance for measuring the fair value of a liability in circumstances in whicha quoted price in an active market for the identical liability is notavailable. In such instances, a reporting entity is required to measure fairvalue utilizing a valuation technique that uses (i) the quoted price ofthe identical liability when traded as an asset, (ii) quoted prices forsimilar liabilities or similar liabilities when traded as assets, or (iii) anothervaluation technique that is consistent with the existing principles of ASC Topic820, such as an income approach or market approach. The new authoritativeaccounting guidance also clarifies that when estimating the fair value of aliability, a reporting entity is not required to include a separate input oradjustment to other inputs relating to the existence of a restriction thatprevents the transfer of the liability. The forgoing new authoritativeaccounting guidance under ASC Topic 820 will be effective for the Company’sfinancial statements beginning October 1, 2009 and is not expected to havea significant impact on the Company’s financial statements.

 

*FASB ASC Topic 320,“Investments - Debt and Equity Securities.”* New authoritativeaccounting guidance under ASC Topic 320, “Investments - Debt and EquitySecurities,” (i) changes existing guidance for determining whether animpairment is other than temporary to debt securities and (ii) replacesthe existing requirement that the entity’s management assert it has both theintent and ability to hold an impaired security until recovery with arequirement that management assert: (a) it does not have the intent tosell the security; and (b) it is more likely than not it will not have tosell the security before recovery of its cost basis. Under ASC Topic 320,declines in the fair value of held-to-maturity and available-for-salesecurities below their cost that are deemed to be other than temporary arereflected in earnings as realized losses to the extent the impairment isrelated to credit losses. The amount of the impairment related to other factorsis recognized in other comprehensive income. The Company adopted the provisionsof the new authoritative accounting guidance under ASC Topic 320 during thesecond quarter of 2009. Adoption of the new guidance did not significantlyimpact the Company’s financial statements.

 

*FASB ASC Topic 825 “FinancialInstruments.”* New authoritative accounting guidance under ASC Topic825,”Financial Instruments,” requires an entity to provide disclosures aboutthe fair value of financial instruments in interim financial information andamends prior guidance to require those disclosures in summarized financialinformation at interim reporting periods. The new interim disclosures requiredunder Topic 825 are included in Note7 – Financial Instruments.

 

*FASB ASC Topic 855,“Subsequent Events.”* New authoritative accountingguidance under ASC Topic 855, “Subsequent Events,” establishes generalstandards of accounting for and disclosure of events that occur after thebalance sheet date but before financial statements are issued or available tobe issued. ASC Topic 855 defines (i) the period after the balance sheetdate during which a reporting entity’s management should evaluate events ortransactions that may occur for potential recognition or disclosure in thefinancial statements, (ii) the circumstances under which an entity shouldrecognize events or transactions occurring after the balance sheet date in itsfinancial statements, and (iii) the disclosures an entity should makeabout events or transactions that occurred after the balance sheet date. Thenew authoritative accounting guidance under ASC Topic 855 became effective forthe Company’s financial statements for periods ending after June 15, 2009and did not have a significant impact on the Company’s financial statements.

 

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**NOTE 3 –SECURITIES**

 

The amortized cost andestimated fair values of debt securities as of September 30, 2009 are asfollows:

 
| ** **                           | ** ** | **Amortized Cost** | ** ** | **Gross Unrealized  Gains** | ** ** | **Gross Unrealized  Losses** | ** ** | **Estimated Fair  Value** | ** ** |
|--------------------------------------|------------|--------------------|------------|-----------------------------|------------|------------------------------|------------|---------------------------|------------|
| Available-for-sale  securities:      |       |               |       |                        |       |                         |       |                      |       |
| U.S. agencies                        |       | $                  | 31,519,509 |                        | $          | 1,494,746                    |       | $                         | —     |   | $ | 33,014,255 |   |
| Collateralized mortgage  obligations |       | 3,058,158          |       | 110,576                     |       | —                       |       | 3,168,734                 |       |
| Municipalities                       |       | 12,963,637         |       | 1,191,704                   |       | —                       |       | 14,155,341                |       |
| SBA Pools                            |       | 1,600,014          |       | —                      |       | (46,451                      | )          | 1,553,563                 |       |
| Asset-Back Security                  |       | 114,636            |       | 1,843                       |       | —                       |       | 116,479                   |       |
| Mutual Fund                          |       | 1,526,602          |       | 29,688                      |       | —                       |       | 1,556,290                 |       |
|                                 |       | $                  | 50,782,556 |                        | $          | 2,828,557                    |       | $                         | (46,451    | ) | $ | 53,564,662 |   |

 

The following tablesdetail the gross unrealized losses and fair values aggregated by investmentcategory and length of time that individual securities have been in acontinuous unrealized loss position at September 30, 2009.

 
| ** **                             | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total**       | ** ** |
|----------------------------------------|------------|-------------------------|------------|-----------------------|------------|-----------------|------------|
| **Description of Securities**          | ** ** | **Fair  Value**         | ** ** | **Unrealized  Loss**  | ** ** | **Fair  Value** | ** ** | **Unrealized  Loss** | ** ** | **Fair  Value** | ** ** | **Unrealized  Loss** | ** ** |
|                                   |       |                    |       |                  |       |            |       |   |   |   |   |   |   |
| U.S. agencies                          |       | $                       | —     |                  | $          | —          |       | $ | — |   | — |   | $ | — |   | $ | — |   |
| Collateralized mortgage  obligations   |       | —                  |       | —                |       | —          |       | — |   | — |   | — |   |
| Municipalities                         |       | —                  |       | —                |       | —          |       | — |   | — |   | — |   |
| SBA Pools                              |       | —                  |       | —                |       | 1,547,982       |       | (46,451 | ) | 1,547,982 |   | (46,451 | ) |
| Asset Backed Securities                |       | —                  |       | —                |       | —          |       | — |   | — |   | — |   |
| Total temporarily  impaired securities |       | $                       | —     |                  | $          | —          |       | $ | 1,547,982 |   | $ | (46,451 | ) | $ | 1,547,982 |   | $ | (46,451 | ) |
|                                        |            |                         |            |                       |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

At September 30,2009, a total of two SBA pools  make upthe total amount of securities in an unrealized loss position for greater than12 months. Management periodically evaluates each available-for-sale investmentsecurity in an unrealized loss position to determine if the impairment istemporary or other than temporary. Management has determined that no investmentsecurity is other than temporarily impaired. The unrealized losses are duesolely to interest rate changes and the Bank has the ability and intent to holdall investment securities with identified impairments resulting from interestrate changes to the earlier of the forecasted recovery or the maturity of theunderlying investment security and it is unlikely that the Bank will be requiredto sell the securities before recovery of their amortized cost.

 

The amortized cost andestimated fair value of debt securities at September 30, 2009, bycontractual maturity or call date, are shown below. Expected maturities willdiffer from contractual maturities because borrowers may have the right to callor prepay obligations with or without call or prepayment penalties.

 
| ** **                              | ** ** | ** **    | ** ** | **Estimated** | ** ** |
|-----------------------------------------|------------|---------------|------------|---------------|------------|
| ** **                              | ** ** | **Amortized** | ** ** | **Fair**      | ** ** |
| ** **                              | ** ** | **Cost**      | ** ** | **Value**     | ** ** |
| Available-for-sale  securities:         |       |          |       |          |       |
| 3  Months or Less                       |       | $             | 510,000    |          | $          | 510,223 |   |
| Due  after one year through five years  |       | 1,976,801     |       | 2,009,439     |       |
| Due  after five years through ten years |       | 13,008,973    |       | 13,729,015    |       |
| Due  after ten years                    |       | 35,286,782    |       | 37,315,985    |       |
|                                    |       | $             | 50,782,556 |          | $          | 53,564,662 |   |

 

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The amortized cost andestimated fair values of debt securities as of December 31, 2008, are asfollows:

 
| ** **                           | ** ** | **Amortized Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross Unrealized  Losses** | ** ** | **Estimated Fair  Value** | ** ** |
|--------------------------------------|------------|-------------------------|------------|------------------------------|------------|-----------------------------------|------------|--------------------------------|------------|
| ** **                           | ** ** | ** **              | ** ** | ** **                   | ** ** | ** **                        | ** ** | ** **                     | ** ** |
| Available-for-sale  securities:      |       |                    |       |                         |       |                              |       |                           |       |
| U.S.  agencies                       |       | $                       | 25,540,641 |                         | $          | 609,957                           |       | $                              | (65,680    | ) | $ | 26,084,918 |   |
| Collateralized  mortgage obligations |       | 3,438,998               |       | 54,471                       |       | (8,861                            | )          | 3,484,608                      |       |
| Municipalities                       |       | 9,970,961               |       | 14,829                       |       | (83,567                           | )          | 9,902,223                      |       |
| SBA  Pools                           |       | 1,820,810               |       | —                       |       | (41,682                           | )          | 1,779,128                      |       |
| Asset-Back  Security                 |       | 198,081                 |       | —                       |       | (81                               | )          | 198,000                        |       |
|                                 |       | $                       | 40,969,491 |                         | $          | 679,257                           |       | $                              | (199,871   | ) | $ | 41,448,877 |   |

 

The following tablesdetail the gross unrealized losses and fair values aggregated by investmentcategory and length of time that individual securities have been in acontinuous unrealized loss position at December 31, 2008.

 
| ** **                                  | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total** | ** ** |
|---------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------|------------|
| ** **                                  | ** ** | ** **                             | ** ** | **Unrealized**                       | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | ** ** | ** ** | **Unrealized** | ** ** |
| **Description of Securities**               | ** ** | **Fair  Value**                        | ** ** | **Loss**                             | ** ** | **Value** | ** ** | **Loss** | ** ** | **Fair  Value** | ** ** | **Loss** | ** ** |
|                                        |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| U.S.  agencies                              |       | $                                      | 2,900,405  |                                 | $          | (13,962   | )          | $ | 3,067,267 |   | $ | (51,718 | ) | $ | 5,967,672 |   | $ | (65,680 | ) |
| Collateralized  mortgage obligations        |       | 618,552                                |       | (2,109                               | )          | 1,085,704 |       | (6,752 | ) | 1,704,256 |   | (8,861 | ) |
| Municipalities                              |       | 9,357,996                              |       | (83,567                              | )          | —    |       | — |   | 9,357,996 |   | (83,567 | ) |
| SBA  Pools                                  |       | —                                 |       | —                               |       | 1,626,502 |       | (41,682 | ) | 1,626,502 |   | (41,682 | ) |
| Asset  Backed Securities                    |       | 198,000                                |       | (81                                  | )          | —    |       | — |   | 198,000 |   | (81 | ) |
| Total  temporarily impaired securities |       | $                                      | 13,074,953 |                                 | $          | (99,719   | )          | $ | 5,779,473 |   | $ | (100,152 | ) | $ | 18,854,426 |   | $ | (199,871 | ) |

 

At December 31,2008, a total of four U.S. agencies, one collateralized mortgage obligationsand two SBA pools make up the total amount of securities in an unrealized lossposition for greater than 12 months. Management periodically evaluates eachavailable-for-sale investment security in an unrealized loss position todetermine if the impairment is temporary or other than temporary. Managementhas determined that no investment security is other than temporarily impaired.The unrealized losses are due solely to interest rate changes and the Bank hasthe ability and intent to hold all investment securities with identifiedimpairments resulting from interest rate changes to the earlier of theforecasted recovery or the maturity of the underlying investment security andit is unlikely that the Bank will be required to sell the securities beforerecovery of their amortized cost.

 

There were no realizedgains or losses on sales of available-for-sale securities during 2009 and 2008,however the Company did recognize a gain of $132,192 for the nine months ended September 30,2009 on certain available-for-sale securities that were partially called. Therewere no other sales of available-for-sale securities during 2009 and 2008.

 

Securities carried at$40,699,006 and $30,117,814 at September 30, 2009 and December 31,2008, respectively, were pledged to secure deposits of public funds.

 

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**OAKVALLEY BANCORP**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

 

**NOTE 4 –LOANS**

 

Loan totals were asfollows:

 
| ** **                            | ** ** | **SEPTEMBER 30,** | ** **  | **DECEMBER 31,** | ** ** |
|---------------------------------------|------------|-------------------|-------------|------------------|------------|
| ** **                            | ** ** | **2009**          | ** **  | **2008**         | ** ** |
| Loans                                 |       |              |        |             |       |
| Commercial real estate                |       | $                 | 281,214,733 |             | $          | 268,741,826 |   |
| Commercial                            |       | 38,776,179        |        | 37,302,286       |       |
| Real estate construction              |       | 55,926,032        |        | 73,321,446       |       |
| Agriculture                           |       | 27,395,078        |        | 25,916,928       |       |
| Residential real estate  and consumer |       | 22,061,847        |        | 22,894,644       |       |
|                                  |       |              |        |             |       |
| Total loans                           |       | 425,373,869       |        | 428,177,130      |       |
|                                  |       |              |        |             |       |
| Less:                                 |       |              |        |             |       |
| Deferred loan fees and  costs, net    |       | (855,415          | )           | (1,034,723       | )          |
| Allowance for loan losses             |       | (6,396,367        | )           | (5,569,496       | )          |
|                                  |       |              |        |             |       |
| Net loans                             |       | $                 | 418,122,087 |             | $          | 421,572,911 |   |

 

Changes in the allowancefor loan losses were as follows:

 
| ** **                                                            | ** ** | **SEPTEMBER 30,** | ** ** | **DECEMBER 31,** | ** ** |
|-----------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                            | ** ** | **2009**          | ** ** | **2008**         | ** ** |
|                                                                  |       |              |       |             |       |
| Balance, beginning of  year                                           |       | $                 | 5,569,496  |             | $          | 4,506,753 |   |
| Provision charged to  operations                                      |       | 4,962,012         |       | 2,188,139        |       |
| Loans charged off                                                     |       | (4,138,994        | )          | (1,114,534       | )          |
| Loan recoveries                                                       |       | 3,853             |       | 4,746            |       |
| Reclassification of  reserve related to off-balance-sheet commitments |       | —            |       | (15,608          | )          |
|                                                                  |       |              |       |             |       |
| Balance, end of period                                                |       | $                 | 6,396,367  |             | $          | 5,569,496 |   |

 

Effective July 1,2008, the expense associated with the allowance for off-balance-sheetcommitments is recorded separately as a component of other expenses.  In2008, the $15,608 reclassification from the allowance for loan losses to otherliabilities is a non-recurring adjustment.

 

The total recordedinvestment in impaired loans at September 30, 2009, was $8,913,581 whichhad a loan loss reserve of $690,252.  The total recorded investment inimpaired loans at December 31, 2008, was $4,078,765 which had a loan lossreserve of $768,719.  No interest income was recognized on impaired loans,while considered impaired during 2009 and 2008.  As of September 30,2009, we had undisbursed funding commitments on ****three**** impaired loans to ****one****borrower totaling $1,107,409 with maturity dates of********April 2010, May 2010and October 2010******.**

 

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**OAKVALLEY BANCORP**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

 

**NOTE 5 –OTHER REAL ESTATE OWNED**

 

As of September 30,2009, seven loans with outstanding balances of $1,990,782 were reclassified toother real estate owned.

 

Real estate propertiesacquired through, or in lieu of, loan foreclosure are to be sold and areinitially recorded at the lower of carrying amount of the loan or fair value ofthe property at the date of foreclosure less selling costs.  Subsequent toforeclosure, valuations are periodically performed and any subject revisions inthe estimate of fair value are reported as adjustment to the carrying value ofthe real estate, provided the adjusted carrying amount does not exceed theoriginal amount at foreclosure.  Revenues and expenses from operations andchanges in the valuation allowance are included in other operating expenses.

 

**NOTE 6****-****OTHER POST-RETIREMENT BENEFIT PLANS**

 

During January 2008,the Bank has awarded certain officers a salary continuation plan (the “Plan”).  Under the Plan, the participants will beprovided with a fixed annual retirement benefit for twenty years after retirement.The Bank is also responsible for certain pre-retirement death benefits underthe Plan. In connection with the implementation of the Plan, the Bank purchasedsingle premium life insurance policies on the life of each of the officerscovered under the Plan. The Bank is the owner and partial beneficiary of theselife insurance policies. The assets of the Plan, under Internal Revenue Serviceregulations, are owned by the Bank and are available to satisfy the Bank’sgeneral creditors.

 

During January 2008the Bank awarded two of its directors a director retirement plan (“DRP”). Underthe DRP, the participants will be provided with a fixed annual retirementbenefit for ten years after retirement. The Bank is also responsible forcertain pre-retirement death benefits under the DRP. In connection with theimplementation of the DRP, the Bank purchased single premium life insurancepolicies on the life of each director covered under the DRP. The Bank is theowner and partial beneficiary of these life insurance policies. The assets ofthe DRP, under Internal Revenue Service regulations, are the property of theBank and are available to satisfy the Bank’s general creditors.

 

Future compensation underboth plans is earned for services rendered through retirement. The Bank accruesfor the salary continuation liability based on anticipated years of service andvesting schedules provided under the plans. The Bank’s current benefitliability is determined based on vesting and the present value of the benefitsat a corresponding discount rate. The discount rate used is an equivalent ratefor investment-grade bonds with lives matching those of the service periodsremaining for the salary continuation contracts, which average approximately20 years.

 

During January 2008,the Bank purchased $4.7 million in bank owned life insurance policies andentered into split-dollar life insurance agreements with certain officers anddirectors.  In connection with theimplementation of the split-dollar agreements, the Bank purchased singlepremium life insurance policies on the life of each of the officers anddirectors covered by the split-dollar life insurance agreements. The Bank isthe owner of the policies and the partial beneficiary in an amount equal to thecash surrender value of the policies.

 

The combined cashsurrender value of all Bank-owned life insurance policies recorded in otherassets on the balance sheet was $10,361,219 and $9,859,234 at September 30,2009 and December 31, 2008, respectively.

 

**NOTE 7 –FINANCIAL INSTRUMENTS**

 

**Fairvalues of financial instruments —** The financial statements include various estimatedfair value information as of September 30, 2009 and December 31,2008. Such information, which pertains to the Bank’s financial instruments,does not purport to represent the aggregate net fair value of the Bank.Further, the fair value estimates are based on various assumptions,methodologies, and subjective considerations, which vary widely among differentfinancial institutions and which are subject to change. The following methodsand assumptions are used by the Bank.

 

*Cashand cash equivalents*— The carrying amounts of cash and cash equivalents approximate their fairvalue.

 

*Securities(including mortgage-backed securities)* — Fair values for securities are based on quotedmarket prices, where available. If quoted market prices are not available, fairvalues are based on quoted market prices of comparable instruments.

 

*Loansreceivable* — Forvariable-rate loans that reprice frequently and have no significant change incredit risk, fair values are based on carrying values. The fair values forother loans (e.g., real estate construction and mortgage, commercial, andinstallment loans) are 

 

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estimated usingdiscounted cash flow analyses, using interest rates currently being offered forloans with similar terms to borrowers of similar credit quality.

 

*Depositliabilities* — Thefair values estimated for demand deposits (interest and non-interest checking,passbook savings, and certain types of money market accounts) are, bydefinition, equal to the amount payable on demand at the reporting date (i.e.their carrying amounts). The carrying amounts for variable-rate, fixed-termmoney market accounts and certificates of deposit approximate their fair valuesat the reporting date. Fair values for fixed-rate certificates of deposit areestimated using a discounted cash flow calculation that applies interest ratescurrently being offered on certificates to a schedule of the aggregate expectedmonthly maturities on time deposits.

 

*FederalHome Loan Bank (FHLB) advances* — Rates currently available to the Bank forborrowings with similar terms and remaining maturities are used to estimate thefair value of the existing debt.

 

*Accruedinterest* — Thecarrying amounts of accrued interest approximate their fair value.

 

*Off-balance-sheetinstruments* —Fair values for the Bank’s off-balance-sheet lending commitments are based onfees currently charged to enter into similar agreements, taking into accountthe remaining terms of the agreements and the credit standing of thecounterparties.

 

The estimated fair valuesof the Bank’s financial instruments at September 30, 2009 are as follows:

 
| ** **                                  | ** ** | ** **   | ** ** | **Estimated** | ** ** |
|---------------------------------------------|------------|--------------|------------|---------------|------------|
| ** **                                  | ** ** | **Carrying** | ** ** | **Fair**      | ** ** |
| ** **                                  | ** ** | **Amount**   | ** ** | **Value**     | ** ** |
| **Financial assets:**                       | ** ** | ** **   | ** ** | ** **    | ** ** |
| Cash  and cash equivalents                  |       | $            | 15,091,446 |          | $          | 15,091,446 |   |
| Securities  available for sale              |       | 53,564,662   |       | 53,564,662    |       |
| Loans                                       |       | 425,373,869  |       | 435,832,855   |       |
| Accrued  interest receivable                |       | 1,772,696    |       | 1,772,696     |       |
|                                        |       |         |       |          |       |
| **Financial liabilities:**                  |       |         |       |          |       |
| Deposits                                    |       | (431,532,833 | )          | (429,414,632  | )          |
| FHLB  advance                               |       | (27,000,000  | )          | (27,247,807   | )          |
| Accrued  interest payable                   |       | (456,072     | )          | (456,072      | )          |
|                                        |       |         |       |          |       |
| **Off-balance-sheet assets (liabilities):** |       |         |       |          |       |
|                                        |       |         |       |          |       |
| Commitments  and standby letters of credit  |       |         |       | (642,114      | )          |
|                                             |            |              |            |               |            |  |  |

 

The estimated fair valuesof the Bank’s financial instruments at December 31, 2008 are as follows:

 
| ** **                                  | ** ** | ** **   | ** ** | **Estimated** | ** ** |
|---------------------------------------------|------------|--------------|------------|---------------|------------|
| ** **                                  | ** ** | **Carrying** | ** ** | **Fair**      | ** ** |
| ** **                                  | ** ** | **Amount**   | ** ** | **Value**     | ** ** |
| **Financial assets:**                       |       |         |       |          |       |
|                                        |       |         |       |          |       |
| Cash  and cash equivalents                  |       | $            | 9,837,860  |          | $          | 9,837,860 |   |
| Securities  available for sale              |       | 41,448,877   |       | 41,448,877    |       |
| Loans                                       |       | 428,177,130  |       | 429,344,847   |       |
| Accrued  interest receivable                |       | 1,886,359    |       | 1,886,359     |       |
|                                        |       |         |       |          |       |
| **Financial liabilities:**                  |       |         |       |          |       |
|                                        |       |         |       |          |       |
| Deposits                                    |       | (378,248,467 | )          | (378,041,128  | )          |
| FHLB  advance                               |       | (69,000,000  | )          | (69,103,323   | )          |
| Accrued  interest payable                   |       | (763,117     | )          | (763,117      | )          |
|                                        |       |         |       |          |       |
| **Off-balance-sheet assets (liabilities):** |       |         |       |          |       |
|                                        |       |         |       |          |       |
| Commitments  and standby letters of credit  |       |         |       | (630,751      | )          |
|                                             |            |              |            |               |            |  |  |

 

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**OAKVALLEY BANCORP**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

 

**NOTE 8 – FAIR VALUEMEASUREMENTS**

 

Fair Value Measurements,which the Company adopted effective January 1, 2008, defines fair value,establishes a framework for measuring fair value, establishes athree-level valuation hierarchy for disclosure of fair value measurementand enhances disclosure requirements for fair value measurements. The valuationhierarchy is based upon the transparency of inputs to the valuation of an assetor liability as of the measurement date. The three levels are defined asfollow:

 

Level 1:  Inputs tothe valuation methodology are quoted prices (unadjusted) for identical assetsor liabilities in active markets.

Level 2:  Inputs tothe valuation methodology include quoted prices for similar assets andliabilities in active markets and inputs that are observable for the asset orliability, either directly or indirectly, for substantially the full term ofthe financial instrument.

Level 3:  Inputs tothe valuation methodology are unobservable and significant to the fair valuemeasurement.

 

In certain cases, theinputs used to measure fair value may fall into different levels of the fairvalue hierarchy.  In such cases, the level in the fair value hierarchywithin which the fair value measurement in its entirety falls has beendetermined based on the lowest level input that is significant to the fairvalue measurement in its entirety.  The Company’s assessment of thesignificance of a particular input to the fair value measurement in itsentirety requires judgment , and considers factors specific to the asset orliability.

 

Assets and liabilitiesmeasured at fair value on a recurring and non-recurring basis are summarizedbelow:

 
| ** **                                                 | ** ** | **Fair Value Measurements at September 30,  2009 Using** | ** ** |
|------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **September 30, 2009**                                                       | ** ** | **Quoted  Prices in  Active  Markets for  Identical  Assets  (Level 1)** | ** ** | **Significant  Other  Observable  Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** |
|                                                       |       |                                                                                   |       |   |   |   |   |   |   |
| Assets  and liabilities measured on a recurring basis:     |       |                                                                                   |       |   |   |   |   |   |   |
| Available-for-sale  securities                             |       | $                                                                                      | 53,564,662 |   | $ | — |   | $ | 53,564,662 |   | $ | — |   |
|                                                       |       |                                                                                   |       |   |   |   |   |   |   |
| Assets  and liabilities measured on a non-recurring basis: |       |                                                                                   |       |   |   |   |   |   |   |
| Impaired  Loans                                            |       | $                                                                                      | 8,223,329  |   | $ | — |   | $ | — |   | $ | 8,223,329 |   |
| Other  real estate owned                                   |       | $                                                                                      | 1,990,782  |   | $ | — |   | $ | — |   | $ | 1,990,782 |   |

 

The fair value ofsecurities available for sale equals quoted market price, if available. If quoted market prices are not available, fair value is determined usingquoted market prices for similar securities.  Changes in fair market valueare recorded in other comprehensive income net of tax.

 

The fair valuemeasurement applies to impaired loans, which includes impaired loans measuredat an observable market price (if available), or at the fair value of the loan’scollateral (if the loan is collateral dependent). Fair value of the loan’scollateral, when the loan is dependent on collateral, is determined byappraisals or independent valuation which is then adjusted for the cost relatedto liquidation of the collateral.  At September 30,2009, impaired loans had a principal balance of $8,913,581, with a valuationallowance of $690,252.  Upon being classifiedas impaired, charge offs were taken to reduce the balance of each loan to anestimate of the collateral fair market value less cost to dispose. Thisestimate was a level 3 valuation.  There was no direct impact on theincome statement.  The charge-offs were recorded as a debit to theallowance for loan losses.

 

Fair value of other realestate owned is determined by appraisals or independent valuation which is thenadjusted for the cost related to liquidation of the property.  Total fair market value at September 30,2009 was $1,990,782 which was a level 3 valuation.  There is a direct impact to the incomestatement as any market value write downs are charged directly to operatingexpenses.  The Bank is required byinternal bank policies to order real estate appraisals on OREO properties everysix months.  In addition, managementevaluates the book values on a quarterly basis for reasonableness and makesfair value adjustments as necessary.

 

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**OAKVALLEY BANCORP**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

 

**NOTE 9 –EARNINGS (LOSS) PER SHARE**

 

Earnings per share (EPS)is calculated based on the weighted average common shares outstanding duringthe period.  Basic EPS excludes dilutionand is calculated by dividing net income available to common shareholders bythe weighted average common shares outstanding. Diluted EPS reflects the potential dilution that could occur ifsecurities or other contracts to issue common stock were exercised or convertedinto common stock.

 
| ** **                                                                           | ** ** | **THREE MONTHS ENDED** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                           | ** ** | **SEPTEMBER  30,**               | ** ** |
| **In thousands (except share and per  share amounts)** | ** ** | **2009**                         | ** ** | **2008** | ** ** |
| BASIC  EARNINGS PER SHARE                                                            |       |                             |       |   |   |
|                                                                                 |       |                             |       |   |   |
| Net  income available to common shareholders                                         |       | $                                | 668,740    |   | $ | 549,396 |   |
| Weighted  average shares outstanding                                                 |       | 7,668,891                        |       | 7,658,252 |   |
| Net  income per common share                                                         |       | $                                | 0.09       |   | $ | 0.07 |   |
|                                                                                 |       |                             |       |   |   |
| DILUTED  EARNINGS PER SHARE                                                          |       |                             |       |   |   |
|                                                                                 |       |                             |       |   |   |
| Net  income available to common shareholders                                         |       | $                                | 668,740    |   | $ | 549,396 |   |
| Weighted  average shares outstanding                                                 |       | 7,668,891                        |       | 7,658,252 |   |
| Effect  of dilutive stock options                                                    |       | 25,167                           |       | 84,839 |   |
| Weighted  average shares of common stock and common stock equivalents                |       | 7,694,058                        |       | 7,743,091 |   |
| Net  income per diluted common share                                                 |       | $                                | 0.09       |   | $ | 0.07 |   |

 
| ** **                                                                           | ** ** | **NINE MONTHS ENDED** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                           | ** ** | **SEPTEMBER  30,**              | ** ** |
| **In thousands (except share and per  share amounts)** | ** ** | **2009**                        | ** ** | **2008** | ** ** |
| BASIC  EARNINGS PER SHARE                                                            |       |                            |       |   |   |
|                                                                                 |       |                            |       |   |   |
| Net  income available to common shareholders                                         |       | $                               | 633,165    |   | $ | 1,877,930 |   |
| Weighted  average shares outstanding                                                 |       | 7,664,075                       |       | 7,636,687 |   |
| Net  income per common share                                                         |       | $                               | 0.08       |   | $ | 0.25 |   |
|                                                                                 |       |                            |       |   |   |
| DILUTED  EARNINGS PER SHARE                                                          |       |                            |       |   |   |
|                                                                                 |       |                            |       |   |   |
| Net  income available to common shareholders                                         |       | $                               | 633,165    |   | $ | 1,877,930 |   |
| Weighted  average shares outstanding                                                 |       | 7,664,075                       |       | 7,636,687 |   |
| Effect  of dilutive stock options                                                    |       | 28,035                          |       | 100,363 |   |
| Weighted  average shares of common stock and common stock equivalents                |       | 7,692,110                       |       | 7,737,050 |   |
| Net  income per diluted common share                                                 |       | $                               | 0.08       |   | $ | 0.24 |   |

 

During the three and ninemonth periods ended September 30, 2009, anti-dilutive weighted average options to purchase 240,187 and 241,888shares of common stock, respectively, with prices ranging from $4.58 to $15.67were outstanding.   Anti-dilutive weighted average options of 260,304and 244,728 were outstanding during the same three and nine month periods of2008, respectively, with prices ranging from $7.00 to $15.67.  Theseoptions were not included in the computation of diluted EPS because the options’exercise price was greater than the average market price of the common shares.These options begin to expire in 2013.

 

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**Item2.   Management’s Discussion and Analysis of Financial Condition andResults of Operations**

 

The following discussionexplains the significant factors affecting our operations and financialposition for the periods presented. The discussion should be read in conjunctionwith our financial statements and the notes related thereto which appear orthat are referenced to elsewhere in this report, and with the auditedconsolidated financial statements and accompanying notes included in our 2008Annual Report.

 

**Forward-LookingStatements**

 

*Somematters discussed in this Form 10-Q may be “forward-looking statements”within the meaning of the Private Litigation Reform Act of 1995 and thereforemay involve risks, uncertainties and other factors which may cause our actualresults to be materially different from the results expressed or implied by ourforward-looking statements.  These statements generally appear with wordssuch as “anticipate,” “believe,” “estimate,” “may,” “intend,” and “expect.” Although management believes that the assumptions and expectations reflected insuch forward-looking statements are reasonable, it can give no assurance thatsuch expectations will prove to be correct.  Factors that could causeactual results to differ from results discussed in forward-looking statementsinclude, but are not limited to: economic conditions (both generally and in themarkets where the Bank operates); competition from other providers of financialservices offered by the Bank; government regulation and legislation; changes ininterest rates; material unforeseen changes in the financial stability andliquidity of the Bank’s credit customers; and other risks as may be detailedfrom time to time in the Company’s filings with the Securities and ExchangeCommission, all of which are difficult to predict and which may be beyond thecontrol of the Company or the Bank.  The Company undertakes no obligationto revise forward-looking statements to reflect events or changes after thedate of this discussion or to reflect the occurrence of unanticipated events.*

 

**CriticalAccounting Estimates**

 

The discussion andanalysis of our financial condition and results of operations is based upon ourfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States of America. The preparationof these financial statements requires management to make estimates andjudgments that affect the reported amounts of assets and liabilities, revenuesand expenses, and related disclosures of contingent assets and liabilities atthe date of our financial statements. Actual results may differ from theseestimates under different assumptions or conditions.

 

*Allowancefor Loan Losses*

 

Accounting for allowancefor loan losses involves significant judgment and assumptions by management andis based on historical data and management’s view of the current economicenvironment. At least on a quarterly basis, our management reviews themethodology and adequacy of allowance for loan losses and reports its assessmentto the Board of Directors for its review and approval.

 

We base our allowance forloan losses on an estimation of probable losses inherent in our loan portfolio.Our methodology for assessing loan loss allowances are intended to reduce thedifferences between estimated and actual losses and involves a detailedanalysis of our loan portfolio in three phases:

 

· the specific review of individual loans,

 

· the segmenting and review of loan poolswith similar characteristics in accordance with SFAS No. 5, “Accountingfor Contingencies,” and

 

· our judgmental estimate based on varioussubjective factors.

 

The first phase of ourmethodology involves the specific review of individual loans to identify andmeasure impairment. We evaluate each loan by use of a risk rating system,except for homogeneous loans, such as automobile loans and home mortgages.Specific risk rated loans are deemed impaired if all amounts, includingprincipal and interest, will likely not be collected in accordance with thecontractual terms of the related loan agreement. Impairment for commercial andreal estate loans is measured either based on the present value of the loan’sexpected future cash flows or, if collection on the loan is collateraldependent, the estimated fair value of the collateral, less selling and holdingcosts.

 

The second phase involvesthe segmenting of the remainder of the risk rated loan portfolio into groups orpools of loans, together with loans with similar characteristics, forevaluation. We determine the calculated loss ratio to each loan pool based onits historical net losses and benchmark it against the levels of other peerbanks.

 

In the third phase, weconsider relevant internal and external factors that may affect thecollectibility of loan portfolio and each group of loan pool. The factorsconsidered are, but are not limited to:

 

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· concentration of credits,

 

· nature and volume of the loan portfolio,

 

· delinquency trends,

 

· non-accrual loan trend,

 

· problem loan trend,

 

· loss and recovery trend,

 

· quality of loan review,

 

· lending and management staff,

 

· lending policies and procedures,

 

· economic and business conditions, and

 

· other external factors.

 

Our management estimatesthe probable effect of such conditions based on our judgment, experience andknown or anticipated trends. Such estimation may be reflected as an additionalallowance to each group of loans, if necessary. Management reviews theseconditions with our senior credit officers. To the extent that any of theseconditions is evidenced by a specifically identifiable problem credit orportfolio segment as of the evaluation date, management’s estimate of theeffect of such condition may be reflected as a specific allowance applicable tosuch credit or portfolio segment. Where any of these conditions is notevidenced by a specific, identifiable problem credit or portfolio segment as ofthe evaluation date, management’s evaluation of the inherent loss related tosuch condition is reflected in the unallocated allowance.

 

Central to our creditrisk management and our assessment of appropriate loss allowance is our loanrisk rating system. Under this system, the originating credit officer assignsborrowers an initial risk rating based on a thorough analysis of each borrower’sfinancial capacity in conjunction with industry and economic trends. Approvalsare made based upon the amount of inherent credit risk specific to thetransaction and are reviewed for appropriateness by senior line and creditadministration personnel. Credits are monitored by line and creditadministration personnel for deterioration in a borrower’s financial conditionwhich may impact the ability of the borrower to perform under the contract.Although management has allocated a portion of the allowance to specific loans,specific loan pools, and off-balance sheet credit exposures (which are reportedseparately as part of other liabilities), the adequacy of the allowance isconsidered in its entirety.

 

*Non-AccrualLoan Policy*

 

Interest on loans iscredited to income as earned and is accrued only if deemed collectible. Accrualof interest is discontinued when a loan is over 90 days delinquent or ifmanagement believes that collection is highly uncertain. Generally, paymentsreceived on nonaccrual loans are recorded as principal reductions. Interestincome is recognized after all principal has been repaid or an improvement inthe condition of the loan has occurred that would warrant resumption ofinterest accruals.

 

*Stock-BasedCompensation*

 

The Company recognizes inthe income statement the grant-date fair value of stock options and otherequity-based forms of compensation issued to employees over the employees’requisite service period (generally the vesting period).  The Bank usesthe straight-line recognition of expenses for awards with graded vesting. The Bank utilizes a binomial pricing model for all grants.  Expected volatility is based on thehistorical volatility of the price of the Bank’s stock for the period equal tothe contractual stock option term. The Bank uses historical data to estimateoption exercise and stock option forfeiture rates within the valuation model.The expected term of options granted for the binomial model is derived fromapplying a historical suboptimal exercise factor to the contractual term of thegrant. For binomial pricing, the risk-free rate for periods is equal to theU.S. Treasury yield at the time of grant and commensurate with the contractualterm of the grant.

 

*OtherReal Estate Owned*

 

Other real estate owned,which represents real estate acquired through foreclosure, or deed in lieu offoreclosure in satisfaction of commercial and real estate loans, is carried atthe lower of cost or estimated fair value less the estimated selling costs ofthe real estate. 

 

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The fair value of theproperty is based upon a current appraisal. The difference between the fairvalue of the real estate collateral and the loan balance at the time oftransfer is recorded as a loan charge off if fair value is lower. Subsequent toforeclosure, management periodically performs valuations and the OREO propertyis carried at the lower of carrying value or fair value, less costs to sell.The  determination of a property’s estimated fair value incorporates (1) revenuesprojected to be realized from disposal of the property, (2) constructionand renovation costs, (3) marketing and transaction costs, and (4) holdingcosts (e.g., property taxes, insurance and homeowners’ association dues). Anysubsequent declines in the fair value of the OREO property after the date oftransfer are recorded through a write-down of the asset. Any subsequentoperating expenses or income, reduction in estimated fair values, and gains orlosses on disposition of such properties are charged or credited to current operations.

 

**Introduction**

 

Oak Valley Community Bankcommenced operations in May 1991.  We are an insured bank under theFederal Deposit Insurance Act and are a member of the Federal Reserve. Since its formation, the Bank has provided basic banking services toindividuals and business enterprises in Oakdale, California and the surroundingareas. The focus of the Bank is to offer a range of commercial banking servicesdesigned for both individuals and small to medium-sized businesses in the twomain areas of service of the Bank: the Central Valley and the Eastern Sierras.

 

The Bank offers a complement ofbusiness checking and savings accounts for its business customers.  TheBank also offers commercial and real estate loans, as well as lines ofcredit.  Real estate loans are generally of a short-term nature for bothresidential and commercial purposes.  Longer-term real estate loans aregenerally made with adjustable interest rates and contain normal provisions foracceleration.  The Bank introduced a mortgage-lending program, CommunityBank Lending Exchange (“CBLX”), at the beginning of 2003.  At September 30,2009, the Bank has originated $227 million in loans for funding by CBLX.

 

The Bank also offers otherservices for both individuals and businesses including online banking, remotedeposit capture, merchant services, night depository, extended hours, traveler’schecks, wire transfer of funds, note collection, and automated teller machinesin a national network.  The Bank does not currently offer internationalbanking or trust services although the Bank may make such services available tothe Bank’s customers through financial institutions with which the Bank hascorrespondent banking relationships.  The Bank does not offer stocktransfer services nor does it directly issue credit cards.

 

Effective July 3,2008, Oak Valley Community Bank became a subsidiary of Oak Valley Bancorp, anewly established bank holding company. Oak Valley Bancorp operates Oak ValleyCommunity Bank as a community bank in the general commercial banking business,with our primary market encompassing the California Central Valley aroundOakdale and Modesto, and the Eastern Sierras. As such, unless otherwise noted,all references are about Oak Valley Bancorp.

 

**Overviewof Results of Operations and Financial Condition**

 

The purpose of thissummary is to provide an overview of the items management focuses on whenevaluating the condition of the Company and its success in implementing itsbusiness and shareholder value strategies. The Company’s business strategy isto operate the Bank as a well-capitalized, profitable and independent communityoriented bank.  The Company’s shareholders value strategy has threemajor themes: (1) enhancing shareholders’ value; (2) making itsretail banking franchise more valuable; and (3) efficiently utilizing itscapital.

 

Management believes thefollowing were important factors in the Company’s performance during thequarter and nine month period ended September 30, 2009:

 

·                  Thanks to our deep roots in the communities that weserve, our focus on customer care and our selectivity in lending, during thefirst nine months of 2009, our performance has been better than mostinstitutions of our size that compete in our market.  Despite the severity of the recessionaffecting our primary market areas, we have been able to increase our coredeposits to $377.4 million and have posted a year-to-date net income per commonshare of $0.08.

 

·                        While recently published economic dataindicate that the current downturn may be easing, it is not clear when or atwhat speed the recession will end. To the extent that the recession continues,it will affect the market areas that we serve and our results accordingly.

 

·                      The Company recognized net incomeavailable to common shareholders of $668,740 and $633,165 for the three andnine month periods ended September 30, 2009 as compared with net incomeavailable to common shareholders of $549,396 and $1,877,930 for the sameperiods in 2008.  The Company recognized net income before preferred stockdividends and accretion of $879,151 and $1,264,398 for the third quarter andnine month period of 2009.  The factorscontributing to these results will be discussed below.

 

·                  The Company recognized $210,411 and $631,233 in thethird quarter and nine month period of 2009 associated with the accrual forpreferred stock dividends and accretion of the preferred stock discount inconnection with the 13,500 shares of

 

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Series A PreferredStock that the U.S. Treasury purchased from the Company in December 2008under the TARP Program. So long as such preferred stock remains outstanding, itwill pay quarterly cumulative dividends at a rate of 5% per year for the firstfive years and thereafter at a rate of 9% per year.  There was no accrual or accretion recognizedin the third quarter and first nine month period of 2008, as the Series APreferred Stock was issued in December 2008.

 

·                  The Company has taken significant steps to reduce therisk of loan losses.   In the three and nine month period ended September 30,2009, the provision for loan losses increased by $323,000 and $3,775,012,respectively, compared to the same periods in 2008.  These increases were mainly due to management’sassessment of the appropriate level for the allowance for loan losses, anincrease in the level of non-accrual loans and overall growth in gross loans. TheCompany continues to monitor its loan portfolio with the objective of avoidingdefaults or write-downs.  Despite these actions, the possibility ofadditional losses can not be eliminated, but the Board of Directors and allemployees continue to work hard to make the best of these continuingchallenging conditions.

 

·                      Net interest income increased $728,074 or13.8% and $2,382,153 or 15.7% for the three and nine month periods ended September 30,2009, respectively, compared to the same periods in 2008.  This increasewas primarily due to the net interest margin increase of 30 and 25 basis pointsand increases in average earning assets of $38.1 million and $50.3 million forthe three and nine month periods ended September 30, 2009, respectively,as compared to the same periods of 2008.  The net interest margin increaseis attributable primarily to liabilities repricing faster than assets in thedeclining rate environment as described in further detail below.

 

·                      For the three and nine month periodsended September 30, 2009, non-interest income increased by $143,164 or22.6% and $102,898 or 5.4% from the same periods in 2008, respectively.  The increase was primarily due to an increasein investment service fee income and the gain on called securities, which waspartially offset by a decrease in NSF fee income as described below.

 

·                      Non-interest expense increased by$209,377 or 4.6% and $316,122 or 2.4% for the three and nine month periodsended September 30, 2009, respectively, as compared to the same periods in2008, primarily due to write downs of OREO property values which was offset bydecreases in salaries and benefits as described below.

 

·                      Total assets increased $13.0 million or2.6% from December 31, 2008.  Total net loans decreased by $3.5million or 0.8% and investment securities increased by $12.1 million or 29.2%from December 31, 2008 to September 30, 2009, while depositsincreased by $53.3 million or 14.1%.

 

**IncomeSummary**

 

For the three and ninemonth periods ended September 30, 2009, the Company recorded net incomeavailable to common shareholders of $668,740 and $633,165, an increase of$119,344 for the quarter and a decrease of $1,244,765 for the nine month periodof 2009, as compared to the $549,396 and $1,877,930 for the same periods in2008.  Return on average assets (annualized) was 0.67% and 0.32% for thethird quarter and nine month period of 2009, respectively, as compared with0.45% and 0.53% for the same periods in 2008.  Annualized return onaverage common equity was 5.73% and 1.85% for the third quarter and nine monthperiod of 2009, respectively, as compared with 4.91% and 5.71% for the sameperiods of 2008.

 

Net income beforeprovisions for income taxes and preferred stock dividends and accretion was up$338,861 for the third quarter and down $1,606,083 for the nine month period of2009 from the comparable 2008 periods.  The income statement components ofthese variances are as follows:

 

***Pre-Tax Income Variance Summary***

***(In thousands)***

*** ***
| ** **                           | ** ** | **Effect on Pre-Tax**        | ** ** | **Effect on Pre-Tax**        | ** ** |
|--------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                           | ** ** | **Income**                   | ** ** | **Income**                   | ** ** |
| ** **                           | ** ** | **Increase (Decrease)** | ** ** | **Increase (Decrease)** | ** ** |
| ** **                           | ** ** | **Three Months**        | ** ** | **Nine Months**         | ** ** |
| Change from 2008 to 2009 in:         | ** ** | ** **                   | ** ** | ** **                   | ** ** |
| Net interest income                  |       | $                            | 728,074    |                         | $          | 2,382,153 |   |
| Provision for loan losses            |       | (323,000                     | )          | (3,775,012                   | )          |
| Non-interest income                  |       | 143,164                      |       | 102,898                      |       |
| Non-interest expense                 |       | (209,377                     | )          | (316,122                     | )          |
| Change in income before income taxes |       | $                            | 338,861    |                         | $          | (1,606,083 | ) |

 

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These variances will beexplained in the discussion below.

 

**NetInterest Income**

 

Net interest income isthe largest source of the Bank’s operating income.  For the three and ninemonth periods ended September 30, 2009, net interest income was $6.02million and $17.56 million, respectively, which represented an increase of$728,074 or 13.8% and $2,382,153 or 15.7%, respectively, from the comparableperiods in 2008.

 

The net interest margin(net interest income as a percentage of average interest earning assets) was5.06% and 4.96% for the three and nine month periods ended September 30,2009, an increase of 30 and 25 basis points as compared to the same periods in2008.  The increase in the net interest margin in 2009 was primarilyattributable to the impact that the decline in market interest rates had on ourliability sensitive balance sheet which caused interest-bearing liabilities todecrease faster than the yields on earning assets.  The compression of the yield on interestearning assets was lessened due to a portion of our loan portfolio that was atthe contractual rate floors.  Inaddition, yield on investments increased by 102 and 108 basis points for thethree and nine month periods ended September 30, 2009, respectively, as aresult of approximately $12.5 million in municipal securities purchased in thefourth quarter of 2008 and first quarter 2009 and the related fully taxableequivalent benefit.

 

The following tablesshows the relative impact of changes in average balances of interest earningassets and interest bearing liabilities, and interest rates earned and paid bythe Company on those assets and liabilities for the three and nine monthperiods ended September 30, 2009 and 2008:

 

***Net Interest Analysis***

*(Dollarsin thousands)*

 
| ** **                                       | ** ** | **Three Months Ended********September 30, 2009** | ** ** | **Three Months Ended********September 30, 2008** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                       | ** ** | **Average  Balance**                                  | ** ** | **Interest  Inc /   Exp**                             | ** ** | **Avg  Rate/   Yield** | ** ** | **Average  Balance** | ** ** | **Interest  Inc /   Exp** | ** ** | **Avg  Rate/  Yield** | ** ** |
| **Assets:**                                      |       |                                                  |       |                                                  |       |   |   |   |   |   |   |   |   |
| Earning assets:                                  |       |                                                  |       |                                                  |       |   |   |   |   |   |   |   |   |
| Gross loans (1) (2)                         |       | $                                                     | 423,947    |                                                  | $          | 6,751 |   | 6.32 | % | $ | 408,476 |   | $ | 7,047 |   | 6.84 | % |
| Investment securities (2)                        |       | 51,811                                                |       | 777                                                   |       | 5.95 | % | 33,475 |   | 416 |   | 4.93 | % |
| Federal funds sold                               |       | 2,095                                                 |       | 1                                                     |       | 0.25 | % | 877 |   | 4 |   | 1.93 | % |
| Interest-earning deposits                        |       | 3,347                                                 |       | 2                                                     |       | 0.23 | % | 242 |   | 1 |   | 0.93 | % |
| Total interest-earning  assets                   |       | 481,200                                               |       | 7,531                                                 |       | 6.21 | % | 443,070 |   | 7,468 |   | 6.69 | % |
| Total noninterest earning  assets                |       | 40,084                                                |       |                                                  |       |   |   | 39,090 |   |   |   |   |   |
| Total Assets                                     |       | 521,284                                               |       |                                                  |       |   |   | 482,160 |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity:**  |       |                                                  |       |                                                  |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                   |       |                                                  |       |                                                  |       |   |   |   |   |   |   |   |   |
| Money market deposits                            |       | 191,740                                               |       | 630                                                   |       | 1.30 | % | 153,260 |   | 927 |   | 2.40 | % |
| NOW deposits                                     |       | 58,643                                                |       | 70                                                    |       | 0.47 | % | 54,711 |   | 102 |   | 0.74 | % |
| Savings deposits                                 |       | 13,362                                                |       | 20                                                    |       | 0.58 | % | 15,225 |   | 47 |   | 1.23 | % |
| Time certificates of  deposit $100,000 or more   |       | 47,678                                                |       | 264                                                   |       | 2.19 | % | 33,177 |   | 280 |   | 3.34 | % |
| Other time deposits                              |       | 52,821                                                |       | 263                                                   |       | 1.97 | % | 43,696 |   | 346 |   | 3.14 | % |
| Other borrowings                                 |       | 31,752                                                |       | 153                                                   |       | 1.91 | % | 73,900 |   | 456 |   | 2.45 | % |
| Total interest-bearing  liabilities              |       | 395,996                                               |       | 1,400                                                 |       | 1.40 | % | 373,969 |   | 2,158 |   | 2.29 | % |
| Noninterest-bearing  liabilities:                |       |                                                  |       |                                                  |       |   |   |   |   |   |   |   |   |
| Noninterest-bearing  deposits                    |       | 62,498                                                |       |                                                  |       |   |   | 60,846 |   |   |   |   |   |
| Other liabilities                                |       | 3,020                                                 |       |                                                  |       |   |   | 2,999 |   |   |   |   |   |
| Total noninterest-bearing  liabilities           |       | 65,518                                                |       |                                                  |       |   |   | 63,845 |   |   |   |   |   |
| Shareholders’ equity                        |       | 59,770                                                |       |                                                  |       |   |   | 44,346 |   |   |   |   |   |
| Total liabilities and  shareholders’ equity |       | $                                                     | 521,284    |                                                  |       |   |   |   | $ | 482,160 |   |   |   |   |   |
| Net interest income                              |       |                                                  |       | $                                                     | 6,131      |   |   |   |   |   | $ | 5,310 |   |   |   |
| Net interest spread (3)                          |       |                                                  |       |                                                  |       | 4.81 | % |   |   |   |   | 4.40 | % |
| Net interest margin (4)                          |       |                                                  |       |                                                  |       | 5.06 | % |   |   |   |   | 4.76 | % |

 

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----

*(1) * Loan fees have been included in thecalculation of interest income.

 

*(2) *Yields on municipal securities and loanshave been adjusted to their fully-taxable equivalents, based on a federalmarginal tax rate of 34.0%.

 

*(3) *Represents the average rate earned oninterest-earning assets less the average rate paid on interest-bearingliabilities.

 

*(4) *Represents net interest income as apercentage of average interest-earning assets.

 
| ** **                                       | ** ** | **Nine months ended September 30, 2009** | ** ** | **Nine months ended September 30, 2008** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Average  Balance**                                         | ** ** | **Interest  Income /  Expense**                              | ** ** | **Avg  Rate/   Yield** | ** ** | **Average  Balance** | ** ** | **Interest  Income /  Expense** | ** ** | **Avg  Rate/  Yield** | ** ** |
| **Assets:**                                      |       |                                                         |       |                                                         |       |   |   |   |   |   |   |   |   |
| Earning assets:                                  |       |                                                         |       |                                                         |       |   |   |   |   |   |   |   |   |
| Gross loans (1) (2)                         |       | $                                                            | 427,513    |                                                         | $          | 20,081 |   | 6.28 | % | $ | 396,583 |   | $ | 20,771 |   | 6.98 | % |
| Investment securities (2)                        |       | 50,422                                                       |       | 2,249                                                        |       | 5.96 | % | 33,964 |   | 1,244 |   | 4.88 | % |
| Federal funds sold                               |       | 1,661                                                        |       | 3                                                            |       | 0.24 | % | 780 |   | 14 |   | 2.36 | % |
| Interest-earning deposits                        |       | 2,201                                                        |       | 4                                                            |       | 0.22 | % | 146 |   | 2 |   | 1.45 | % |
| Total interest-earning  assets                   |       | 481,797                                                      |       | 22,337                                                       |       | 6.20 | % | 431,473 |   | 22,031 |   | 6.80 | % |
| Total noninterest earning  assets                |       | 38,626                                                       |       |                                                         |       |   |   | 36,287 |   |   |   |   |   |
| Total Assets                                     |       | 520,423                                                      |       |                                                         |       |   |   | 467,760 |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity:**  |       |                                                         |       |                                                         |       |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                   |       |                                                         |       |                                                         |       |   |   |   |   |   |   |   |   |
| Money market deposits                            |       | 176,878                                                      |       | 1,910                                                        |       | 1.44 | % | 145,810 |   | 2,748 |   | 2.51 | % |
| NOW deposits                                     |       | 56,654                                                       |       | 215                                                          |       | 0.51 | % | 54,994 |   | 298 |   | 0.72 | % |
| Savings deposits                                 |       | 14,003                                                       |       | 86                                                           |       | 0.83 | % | 16,313 |   | 227 |   | 1.85 | % |
| Time certificates of  deposit $100,000 or more   |       | 46,598                                                       |       | 850                                                          |       | 2.44 | % | 39,418 |   | 1,166 |   | 3.94 | % |
| Other time deposits                              |       | 53,081                                                       |       | 858                                                          |       | 2.16 | % | 42,209 |   | 1,130 |   | 3.57 | % |
| Other borrowings                                 |       | 49,123                                                       |       | 540                                                          |       | 1.47 | % | 60,551 |   | 1,222 |   | 2.69 | % |
| Total interest-bearing  liabilities              |       | 396,337                                                      |       | 4,459                                                        |       | 1.50 | % | 359,295 |   | 6,791 |   | 2.52 | % |
| Noninterest-bearing  liabilities:                |       |                                                         |       |                                                         |       |   |   |   |   |   |   |   |   |
| Noninterest-bearing  deposits                    |       | 61,776                                                       |       |                                                         |       |   |   | 61,556 |   |   |   |   |   |
| Other liabilities                                |       | 2,954                                                        |       |                                                         |       |   |   | 3,127 |   |   |   |   |   |
| Total noninterest-bearing  liabilities           |       | 64,730                                                       |       |                                                         |       |   |   | 64,683 |   |   |   |   |   |
| Shareholders’ equity                        |       | 59,356                                                       |       |                                                         |       |   |   | 43,782 |   |   |   |   |   |
| Total liabilities and  shareholders’ equity |       | $                                                            | 520,423    |                                                         |       |   |   |   | $ | 467,760 |   |   |   |   |   |
| Net interest income                              |       |                                                         |       | $                                                            | 17,878     |   |   |   |   |   | $ | 15,240 |   |   |   |
| Net interest spread (3)                          |       |                                                         |       |                                                         |       | 4.69 | % |   |   |   |   | 4.28 | % |
| Net interest margin (4)                          |       |                                                         |       |                                                         |       | 4.96 | % |   |   |   |   | 4.71 | % |

 

----

*(1) * Loan fees have been included in thecalculation of interest income.

 

*(2) *Yields on municipal securities and loanshave been adjusted to their fully-taxable equivalents, based on a federalmarginal tax rate of 34.0%.

 

*(3) *Represents the average rate earned oninterest-earning assets less the average rate paid on interest-bearingliabilities.

 

*(4) *Represents net interest income as apercentage of average interest-earning assets.

 

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Shown in the followingtables are the relative impacts on net interest income of changes in theaverage outstanding balances (volume) of earning assets and interestbearing liabilities and the rates earned and paid by the Company on thoseassets and liabilities for the three and nine month periods ended September 30,2009 and 2008.  Changes in interest income and expense that are notattributable specifically to either rate or volume are allocated to the ratecolumn below.

 

***Rate / Volume Variance Analysis***

*(Inthousands)*

 
| ** **                         | ** ** | **For the Three Months  Ended September 30,** | ** ** |
|------------------------------------|------------|----------------------------------------------------|------------|
| ** **                         | ** ** | **2009 vs 2008**                                   | ** ** |
| ** **                         | ** ** | **Increase (Decrease)**                            | ** ** |
| ** **                         | ** ** | **in interest income and  expense**                | ** ** |
| ** **                         | ** ** | **due to changes in:**                             | ** ** |
| ** **                         | ** ** | **Volume**                                         | ** ** | **Rate** | ** ** | **Total** | ** ** |
| **Interest  income:**              |       |                                               |       |   |   |   |   |
| Gross loans (1)                    |       | $                                                  | 267        |   | $ | (563 | ) | $ | (296 | ) |
| Investment securities              |       | 228                                                |       | 134 |   | 362 |   |
| Federal funds sold                 |       | 6                                                  |       | (9 | ) | (3 | ) |
| Interest-earning deposits          |       | 7                                                  |       | (6 | ) | 1 |   |
| **Total  interest income**         |       | $                                                  | **508**    |   | $ | **(444** | **)** | $ | **64** |   |
|                               |       |                                               |       |   |   |   |   |
| **Interest  expense:**             |       |                                               |       |   |   |   |   |
| Money market deposits              |       | 233                                                |       | (529 | ) | (296 | ) |
| NOW deposits                       |       | 7                                                  |       | (40 | ) | (33 | ) |
| Savings deposits                   |       | (6                                                 | )          | (22 | ) | (28 | ) |
| Time CD $100K or more              |       | 122                                                |       | (138 | ) | (16 | ) |
| Other time deposits                |       | 72                                                 |       | (155 | ) | (83 | ) |
| Other borrowings                   |       | (260                                               | )          | (41 | ) | (301 | ) |
| **Total  interest expense**        |       | $                                                  | **169**    |   | $ | **(925** | **)** | $ | **(757** | **)** |
| ** **                         | ** ** | ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Change  in net interest income** |       | $                                                  | **340**    |   | $ | **481** |   | $ | **821** |   |

 
| ** **                         | ** ** | **For the Nine Months Ended  September 30,** | ** ** |
|------------------------------------|------------|---------------------------------------------------|------------|
| ** **                         | ** ** | **2009 vs 2008**                                  | ** ** |
| ** **                         | ** ** | **Increase (Decrease)**                           | ** ** |
| ** **                         | ** ** | **in interest income and  expense**               | ** ** |
| ** **                         | ** ** | **due to changes in:**                            | ** ** |
| ** **                         | ** ** | **Volume**                                        | ** ** | **Rate** | ** ** | **Total** | ** ** |
| **Interest  income:**              |       |                                              |       |   |   |   |   |
| Gross loans (1)                    |       | $                                                 | 1,620      |   | $ | (2,310 | ) | $ | (690 | ) |
| Investment securities              |       | 603                                               |       | 402 |   | 1,005 |   |
| Federal funds sold                 |       | 16                                                |       | (27 | ) | (11 | ) |
| Interest-earning deposits          |       | 22                                                |       | (20 | ) | 2 |   |
| **Total  interest income**         |       | $                                                 | **2,261**  |   | $ | **(1,955** | **)** | $ | **306** |   |
|                               |       |                                              |       |   |   |   |   |
| **Interest  expense:**             |       |                                              |       |   |   |   |   |
| Money market deposits              |       | 585                                               |       | (1,423 | ) | (838 | ) |
| NOW deposits                       |       | 9                                                 |       | (93 | ) | (84 | ) |
| Savings deposits                   |       | (32                                               | )          | (108 | ) | (140 | ) |
| Time CD $100K or more              |       | 212                                               |       | (529 | ) | (317 | ) |
| Other time deposits                |       | 291                                               |       | (563 | ) | (272 | ) |
| Other borrowings                   |       | (231                                              | )          | (449 | ) | (680 | ) |
| **Total  interest expense**        |       | $                                                 | **834**    |   | $ | **(3,165** | **)** | $ | **(2,331** | **)** |
| ** **                         | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Change  in net interest income** |       | $                                                 | **1,427**  |   | $ | **1,210** |   | $ | **2,637** |   |

 

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----

*(1) * Loan fees have been included in thecalculation of interest income.

 

The table above reflectsthe market interest rate decline has impacted liabilities slightly more thanassets as indicated by the increase of $1,210,000 in net interest income due tothe rate change for the nine month period of 2009.  The increased loanvolume and the overall change in mix of deposit balances contributed anincrease of $1,427,000 to net interest income.

 

**Non-InterestIncome**

 

Non-interest incomerepresents service charges on deposit accounts and other non-interest relatedcharges and fees, including fees from the sale of loans and investment servicefee income.  For the three and nine month periods ended September 30,2009, non-interest income was $777,636 and $2,023,322, an increase of $143,164or 22.6% and $102,898 or 5.4%, respectively, compared to the same periods in2008.

 

The following table showsthe major components of non-interest income:

 
| ** **                                         | ** ** | **For the Three Months Ended September 30,** | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                         | ** ** | **2009**                                          | ** ** | **2008**                                         | ** ** | **$ change** | ** ** | **%  change** | ** ** | **2009** | ** ** | **2008** | ** ** | **$ change** | ** ** | **%  change** | ** ** |
| Service charges on  deposits                       |       | $                                                 | 300,282    |                                             | $          | 337,264 |   | $ | (36,982 | ) | (11.0 | )% | $ | 875,229 |   | $ | 984,556 |   | $ | (109,327 | ) | (11.1 | )% |
| Earnings on cash surrender  valueof life insurance |       | 101,057                                           |       | 99,241                                           |       | 1,816 |   | 1.8 | % | 303,170 |   | 279,759 |   | 23,411 |   | 8.4 | % |
| Mortgage commissions                               |       | 38,143                                            |       | 23,410                                           |       | 14,733 |   | 62.9 | % | 127,160 |   | 94,859 |   | 32,301 |   | 34.1 | % |
| Other income                                       |       | 338,154                                           |       | 174,557                                          |       | 163,597 |   | 93.7 | % | 717,763 |   | 561,250 |   | 156,513 |   | 27.9 | % |
| Total non-interest income                          |       | $                                                 | 777,636    |                                             | $          | 634,472 |   | $ | 143,164 |   | 22.6 | % | $ | 2,023,322 |   | $ | 1,920,424 |   | $ | 102,898 |   | 5.4 | % |

 

The increase to totalnon-interest income is due in part to the gain on called securities of $77,811and $132,192, respectively, compared to no gains recorded in 2008 and increasedinvestment service fee income of $49,059 and $19,613, respectively, for thethree and nine month periods ended September 30, 2009 compared to the sameperiods in 2008. Gain on called securities and investment service fee income isincluded in the “other income” line item in the above table.  Offsetting these increases was a decrease toservice charges on deposits of $36,982 or 11.0% and $109,327 or 11.1% in thethree and nine month periods ended September 30, 2009, respectively, ascompared to the same periods in 2008. The Bank continues to expand its offerings to the consumer and businessdepositor.

 

**Non-InterestExpense**

 

Non-interest expenserepresents salaries and benefits, occupancy expenses, professional expenses,outside services, and other miscellaneous expenses necessary to conductbusiness.

 

The following table showsthe major components of non-interest expenses:

 
| ** **                        | ** ** | **For the Three Months Ended September 30,** | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|-----------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                        | ** ** | **2009**                                          | ** ** | **2008**                                         | ** ** | **$ change** | ** ** | **%  change** | ** ** | **2009** | ** ** | **2008** | ** ** | **$ change** | ** ** | **%  change** | ** ** |
| Salaries and employeebenefits     |       | $                                                 | 1,974,022  |                                             | $          | 2,319,467 |   | $ | (345,445 | ) | (14.9 | )% | $ | 5,889,247 |   | $ | 7,200,869 |   | $ | (1,311,622 | ) | (18.2 | )% |
| Occupancy expenses                |       | 658,928                                           |       | 675,728                                          |       | (16,800 | ) | (2.5 | )% | 2,031,844 |   | 2,015,674 |   | 16,170 |   | 0.8 | % |
| Data processing fees              |       | 220,181                                           |       | 193,009                                          |       | 27,172 |   | 14.1 | % | 672,597 |   | 562,007 |   | 110,590 |   | 19.7 | % |
| OREO expenses                     |       | 915,623                                           |       | 485,292                                          |       | 430,331 |   | 88.7 | % | 1,974,375 |   | 936,370 |   | 1,038,005 |   | 110.9 | % |
| Assessments  (FDIC &DFI) |       | 230,269                                           |       | 87,160                                           |       | 143,109 |   | 164.2 | % | 667,355 |   | 259,056 |   | 408,299 |   | 157.6 | % |
| Other operating expenses          |       | 745,563                                           |       | 774,553                                          |       | (28,990 | ) | (3.7 | )% | 2,234,073 |   | 2,179,393 |   | 54,680 |   | 2.5 | % |
| Total non-interest expense        |       | $                                                 | 4,744,586  |                                             | $          | 4,535,209 |   | $ | 209,377 |   | 4.6 | % | $ | 13,469,491 |   | $ | 13,153,369 |   | $ | 16,122 |   | 2.4 | % |

 

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Non-interest expensesincreased by $209,377 or 4.6% and $316,122 or 2.4% for the three and ninemonths ended September 30, 2009, respectively, as compared to the sameperiods of 2008.  Salaries and employee benefits decreased $345,445 and$1,311,622 for the three and nine months ended September 30, 2009,respectively, as compared to the same periods of 2008 as a result of a reductionin full time equivalent employees in effort to improve operating efficiency andan increase in deferred loan costs.  Data processing fees increased by$27,172 and $110,590 for the three and nine month periods 2009, respectively,compared to the same periods of 2008, as a result of an increased number oftransaction accounts.  FDIC and DFIassessments increased by $143,109 and $408,299, respectively, compared to thesame three and nine month periods of 2008. OREO expenses were $915,623 and $1,974,375 in the third quarter and ninemonth period of 2009, respectively, compared to $485,292 and $936,370 for thecomparable periods of 2008.  Theseexpenses resulted from various overhead costs and market value write downs associatedwith the five properties classified as other real estate owned.

 

Management anticipatesthat noninterest expense will continue to increase as we continue togrow.  However, management remains committed to cost-control andefficiency, and we expect to keep these increases to a minimum relative togrowth.

 

**IncomeTaxes**

 

Provision for incometaxes for the third quarter of 2009 was $248,701, an increase of $9,106 or 3.8%compared to the same period of 2008.  Thecompany recorded a tax benefit of $109,401 for the nine months ended September 30,2009, a decrease in expense of $992,551 or 112.4% from the same period in2008.  The tax provision and tax benefit recognized in the respectiveperiods of 2009 are disproportional compared to pre-tax income assumingmarginal tax rates or historical effective tax rates are applied to pre-taxincome.  This is primarily due to taxcredits from California Enterprise Zones and low income housing projects aswell as tax free-income on loans within these enterprise zones and municipalsecurities and loans that comprise a larger proportion of pre-tax income in2009 as compared to 2008.  Certain taxcredits and deductions are recognized by the Company regardless of the amountof pre-tax income or loss, which further increases the tax benefit andexaggerates the effective tax rates.

 

**AssetQuality**

 

Nonperforming assetsconsist of loans on non-accrual status, loans 90 days or more past due andstill accruing interest, loans restructured, where the terms of repayment havebeen renegotiated resulting in a reduction or deferral of interest orprincipal, and other real estate owned (“OREO”).

 

Loans are generallyplaced on non-accrual status when they become 90 days past due, unlessmanagement believes the loan is adequately collateralized and in the process ofcollection. The past due loans may or may not be adequately collateralized, butcollection efforts are continuously pursued. Loans may be restructured bymanagement when a borrower has experienced some changes in financial status,causing an inability to meet the original repayment terms, and where we believethe borrower will eventually overcome those circumstances and repay the loan infull. OREO consists of properties acquired by foreclosure or similar means andwhich management intends to offer for sale.

 

Non-accrual loans totaled$8.9 million at September 30, 2009, as compared to $4.1 million at December 31,2008.  The non-accrual loans as of September 30, 2009 are loans madeto five borrowers for purposes of real estate construction and commercial realestate.

 

OREO totaled $2.0 millionas of September 30, 2009 and consists of five properties that wereacquired through foreclosure including residential land lots and a commercialreal estate property.

 

The following tablepresents information about the Company’s non-performing loans, including assetquality ratios as of September 30, 2009 and December 31, 2008:

 

25

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Table of Contents

 

***Non-Performing Assets***

*(inthousands)*

 
| ** **                                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                               | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| Loans  in nonaccrual status                              |       | $                      | 8,914      |                  | $          | 4,078 |   |
| Loans  past due 90 days or more and accruing             |       | —                 |       | 643                   |       |
| Restructured  loans                                      |       | —                 |       | —                |       |
| Total  nonperforming loans                               |       | 8,914                  |       | 4,721                 |       |
| Other  real estate owned                                 |       | 1,991                  |       | 2,746                 |       |
| Total  nonperforming assets                              |       | $                      | 10,905     |                  | $          | 7,467 |   |
|                                                     |       |                   |       |                  |       |
| Allowance  for loan losses                               |       | $                      | 6,396      |                  | $          | 5,569 |   |
|                                                     |       |                   |       |                  |       |
| Asset  quality ratios:                                   |       |                   |       |                  |       |
| Non-performing  assets to total assets                   |       | 2.09                   | %          | 1.47                  | %          |
| Non-performing  loans to total loans                     |       | 2.10                   | %          | 1.10                  | %          |
| Allowance  for loan losses to total loans                |       | 1.50                   | %          | 1.30                  | %          |
| Allowance  for loan losses to total non-performing loans |       | 71.76                  | %          | 117.96                | %          |

 

**Allowancefor Loan and Lease Losses (“ALLL”)**

 

In anticipation of creditrisk inherent in our lending business, we routinely set aside allowancesthrough charges to earnings. Such charges are not only made for the outstandingloan portfolio, but also for off-balance sheet items, such as commitments toextend credits or letters of credit. Charges made for the outstanding loanportfolio have been  credited to theallowance for loan losses, whereas charges for off-balance sheet items havebeen  credited to the reserve foroff-balance sheet items, which is presented as a component of otherliabilities.  The Bank recorded loan loss provisions of $925,000 and$4,962,012 for the three and nine month periods in 2009, respectively, whichrepresented a $323,000 and $3,775,012 increase from the provisions recorded inthe same periods of 2008.

 

The allowance for loanlosses increased by 14.8%, or $826,871, to $6.39 million at September 30,2009, as compared with $5.57 million at December 31, 2008.  TheBank recognized the increase in the allowance for loan losses during the firstnine months of the year due to the loan loss provision of $4.96 million whichwas offset by net loan charge-offs.  The weak business climate adverselyimpacted the financial conditions of certain Bank clients in addition todecreases in collateral values which resulted in net loan charge-offs of $4.14 millionfor the first nine months of 2009, compared to $1.03 million for the first ninemonths of 2008. The increase to the allowance for loan losses combined with aslight decrease in our loan portfolio resulted in an increase to the allowancefor loan losses as a percentage of total loans to 1.50% at September 30,2009, as compared to 1.30% at December 31, 2008.

 

Management reviews theseconditions with our senior credit officers. To the extent that any of theseconditions may be attributed to a specifically identifiable problem credit orportfolio segment as of the evaluation date, management’s estimate of theeffect of such condition may be reflected as a specific allowance applicable tosuch credit or portfolio segment. Where any of these conditions may not beattributed to a specific, identifiable problem credit or portfolio segment asof the evaluation date, management’s evaluation of the inherent loss related tosuch condition is reflected in the unallocated allowance. Although managementhas allocated a portion of the allowance to specific loan categories, theadequacy of the allowance is considered in its entirety as appropriate from timeto time.

 

The following tableprovides an analysis of the changes in the ALLL for the nine month periodsended September 30, 2009 and 2008:

 

***Allowance for Loan and Lease Losses***

*(dollarsin thousands)*

* *
| ** **                                                            | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                            | ** ** | **September 30,**          | ** ** |
| ** **                                                            | ** ** | **2009**                        | ** ** | **2008** | ** ** |
| Balance at beginning of  period                                       |       | $                               | 5,569      |   | $ | 4,507 |   |
| Provision for loan losses                                             |       | 4,962                           |       | 1,187 |   |
| Loans charged off                                                     |       | (4,139                          | )          | (1,032 | ) |
| Recoveries of previous  charge-offs                                   |       | 4                               |       | 4 |   |
| Net charge-offs                                                       |       | (4,135                          | )          | (1,028 | ) |
| Reclassification of reserve related to off-balance-sheet  commitments |       | 0                               |       | (16 | ) |
| Balance at end of period                                              |       | $                               | 6,396      |   | $ | 4,650 |   |
|                                                                  |       |                            |       |   |   |
| Allowance for loan losses  to total loans                             |       | 1.50                            | %          | 1.12 | % |
| Net charge-offs to  average loans (annualized)                        |       | 1.29                            | %          | 0.35 | % |
| Provision for loan losses  to average loans (annualized)              |       | 1.55                            | %          | 0.40 | % |

 

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The Bank makes provisionsfor loan losses when required to bring the total allowance for loan and leaselosses to a level deemed appropriate for the level of risk in the loanportfolio.  At least quarterly, management conducts an assessment of theoverall quality of the loan portfolio and general economic trends in the localmarket.  The determination of the appropriate level for the allowance isbased on that review, considering such factors as historical experience, thevolume and type of lending conducted, the amount of and identified potentialloss associated with specific nonperforming loans, regulatory policies, generaleconomic conditions, and other factors related to the collectibility of loansin the portfolio.

 

Although managementbelieves the allowance at September 30, 2009 was adequate to absorbprobable losses from any known and inherent risks in the portfolio, noassurance can be given that economic conditions which adversely affect ourservice areas or other variables will not result in increased losses in theloan portfolio in the future.

 

**InvestmentActivities**

 

Investments are a keysource of interest income. Management of our investment portfolio is set inaccordance with strategies developed and overseen by our Investment Committee.Investment balances, including cash equivalents and interest-bearing depositsin other financial institutions, are subject to change over time based on ourasset/liability funding needs and interest rate risk management objectives. Ourliquidity levels take into consideration anticipated future cash flows and allavailable sources of credits, and are maintained at levels management believesare appropriate to assure future flexibility in meeting anticipated fundingneeds.

 

*CashEquivalents and Interest-bearing Deposits in other Financial Institutions*

 

The Bank holds federalfunds sold, unpledged available-for-sale securities and salable governmentguaranteed loans to help meet liquidity requirements and provide temporaryholdings until the funds can be otherwise deployed or invested. As of September 30,2009, and December 31, 2008, we had $15.1 million and $9.8 million,respectively, in cash and cash equivalents.

 

*InvestmentSecurities*

 

Management of ourinvestment securities portfolio focuses on providing an adequate level ofliquidity and establishing an interest rate-sensitive position, while earningan adequate level of investment income without taking undue risk. Investmentsecurities that we intend to hold until maturity are classified asheld-to-maturity securities, and all other investment securities are classifiedas available-for-sale.  Currently, all of our investment securities areclassified as available-for-sale. The carrying values of available-for-saleinvestment securities are adjusted for unrealized gains or losses as avaluation allowance and any gain or loss is reported on an after-tax basis as acomponent of other comprehensive income.

 

Management has evaluatedthe investment securities portfolio to determine if the impairment of anysecurity in an unrealized loss position is temporary or other thantemporary.  Management has determined that no investment security is otherthan temporarily impaired.  The unrealized losses are due solely tointerest rate changes.

 

**Deposits**

 

Total deposits at September 30,2009 were $431.5 million, a $53.3 million or 14.1% increase from the deposittotal of $378.2 million at December 31, 2008.  Average depositsincreased $48.7 million to $409.0 million for the nine month period ended September 30,2009 as compared to the same period in 2008. We attracted deposits due to thesafety and soundness of the Bank and our focus on customer service.

 

***Deposits***

***(in thousands)***

 
| ** **      | ** ** | **September 30,** | ** **        | **December 31,** | ** ** | **Nine months change** | ** ** |
|-----------------|------------|------------------------|-------------------|-----------------------|------------|------------------------|------------|
| ** **      | ** ** | **2009**               | ** **        | **2008**              | ** ** | **$**                  | ** ** | **%** | ** ** |
|            |       |                   |              |                  |       |                   |       |   |   |
| Demand          |       | $                      | 61,196            |                  | $          | 64,277                 |       | $ | (3,081 | ) | (4.8 | )% |
| NOW             |       | 61,549                 |              | 53,485                |       | 8,064                  |       | 15.1 | % |
| MMDA            |       | 199,640                |              | 157,351               |       | 42,289                 |       | 26.9 | % |
| Savings         |       | 13,399                 |              | 12,532                |       | 867                    |       | 6.9 | % |
| Time < 100K  |       | 40,857                 |              | 46,563                |       | (5,706                 | )          | (12.3 | )% |
| Time > $100K |       | 54,892                 |              | 44,040                |       | 10,852                 |       | 24.6 | % |
| ** **      |       | $                      |  **431,533** |                  | $          | **378,248**            |       | $ | **53,285** | ** ** | **14.1** | **%** |

 

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Because our client baseis comprised primarily of commercial and industrial accounts, individualaccount balances are generally higher than those of consumer-oriented banks.Five of our clients carry deposit balances of more than 1% of our total deposits,none of which had a deposit balance of more than 3% of total deposits at September 30,2009.

 

Since our deposit growthstrategy emphasizes core deposit growth we have avoided relying on brokereddeposits as a consistent source of funds.  The only brokered deposits theBank holds are from CDARS, a certificate of deposit program that exchangesfunds with other network banks to offer full FDIC insurance coverage to thecustomer.  The Bank had $9.2 million in brokered deposits as of September 30,2009 as compared to $10.5 million at December 31, 2008.

 

**Borrowings**

 

Although deposits are theprimary source of funds for our lending and investment activities and forgeneral business purposes, we may obtain advances from the Federal Home LoanBank of San Francisco (“FHLB”) as an alternative to retail deposit funds. Ouroutstanding FHLB advances decreased by $42.0 million at September 30, 2009to $27.0 million, compared to $69.0 million at December 31, 2008 due tothe increase in deposits. See “Liquidity Management” below for the details onthe FHLB borrowings program.

 

**CapitalRatios**

 

We are subject to variousregulatory capital requirements administered by federal banking agencies.Failure to meet minimum capital requirements can trigger regulatory actions thatcould have a material adverse effect on our financial statements andoperations. Under capital adequacy guidelines and the regulatory framework forprompt corrective action, we must meet specific capital guidelines that rely onquantitative measures of our assets, liabilities and certain off-balance-sheetitems as calculated under regulatory accounting practices. Our capital amountsand classification are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors.

 

The following table showsthe Oak Valley Community Bank’s and Oak Valley Bancorp’s capital ratios, ascalculated under regulatory guidelines, compared to the regulatory minimumcapital ratios and the regulatory minimum capital ratios needed to qualify as a“well-capitalized” institution at September 30, 2009 and December 31,2008:

 

***Oak Valley Community Bank Capital Ratios —***

***(dollars in thousands)***

 
| ** **                                | ** ** | ** ** | ** ** | ** **           | ** ** | **Amount of Capital Required** | ** ** |
|-------------------------------------------|------------|------------|------------|----------------------|------------|-----------------------------------------------|------------|
| ** **                                | ** ** | ** ** | ** ** | ** **           | ** ** | **To Be**                                | ** ** | **To Be Adequately** | ** ** |
| ** **                                | ** ** | **Actual** | ** ** | **Well-Capitalized** | ** ** | **Capitalized**                               | ** ** |
| ** **                                | ** ** | **Amount** | ** ** | **Ratio**            | ** ** | **Amount**                                    | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of September 30, 2009:**        |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| Total  Capital (to Risk-Weighted Assets)  |       | $          | 64,253     |                 | 13.3       | %                                             | $          | 48,180 |   | 10 | % | $ | 38,544 |   | 8 | % |
| Tier  1 Capital (to Risk-Weighted Assets) |       | $          | 58,211     |                 | 12.1       | %                                             | $          | 28,908 |   | 6 | % | $ | 19,272 |   | 4 | % |
| Tier  1 Capital (to Average Assets)       |       | $          | 58,211     |                 | 11.2       | %                                             | $          | 26,058 |   | 5 | % | $ | 20,846 |   | 4 | % |
|                                      |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| **As of December 31, 2008:**         |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| Total  Capital (to Risk-Weighted Assets)  |       | $          | 63,379     |                 | 13.3       | %                                             | $          | 47,758 |   | 10 | % | $ | 38,206 |   | 8 | % |
| Tier  1 Capital (to Risk-Weighted Assets) |       | $          | 57,635     |                 | 12.1       | %                                             | $          | 28,655 |   | 6 | % | $ | 19,103 |   | 4 | % |
| Tier  1 Capital (to Average Assets)       |       | $          | 57,635     |                 | 11.8       | %                                             | $          | 24,492 |   | 5 | % | $ | 19,593 |   | 4 | % |

 

***Oak Valley Bancorp Capital Ratios —***

***(dollars in thousands)***

 
| ** **                                | ** ** | ** ** | ** ** | ** **           | ** ** | **Amount of Capital Required** | ** ** |
|-------------------------------------------|------------|------------|------------|----------------------|------------|-----------------------------------------------|------------|
| ** **                                | ** ** | ** ** | ** ** | ** **           | ** ** | **To Be**                                | ** ** | **To Be Adequately** | ** ** |
| ** **                                | ** ** | **Actual** | ** ** | **Well-Capitalized** | ** ** | **Capitalized**                               | ** ** |
| ** **                                | ** ** | **Amount** | ** ** | **Ratio**            | ** ** | **Amount**                                    | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **As of September 30, 2009**         |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| Total  Capital (to Risk-Weighted Assets)  |       | $          | 64,470     |                 | 13.4       | %                                             | N/A        |   | N/A |   | $ | 38,555 |   | 8 | % |
| Tier  1 Capital (to Risk-Weighted Assets) |       | $          | 58,426     |                 | 12.1       | %                                             | N/A        |   | N/A |   | $ | 19,277 |   | 4 | % |
| Tier  1 Capital (to Average Assets)       |       | $          | 58,426     |                 | 11.2       | %                                             | N/A        |   | N/A |   | $ | 20,851 |   | 4 | % |
|                                      |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| **As of December 31, 2008:**         |       |       |       |                 |       |                                          |       |   |   |   |   |   |   |
| Total  Capital (to Risk-Weighted Assets)  |       | $          | 63,440     |                 | 13.3       | %                                             | N/A        |   | N/A |   | $ | 38,211 |   | 8 | % |
| Tier  1 Capital (to Risk-Weighted Assets) |       | $          | 57,696     |                 | 12.1       | %                                             | N/A        |   | N/A |   | $ | 19,106 |   | 4 | % |
| Tier  1 Capital (to Average Assets)       |       | $          | 57,696     |                 | 11.8       | %                                             | N/A        |   | N/A |   | $ | 19,594 |   | 4 | % |

 

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**LiquidityManagement**

 

Since the Company is aholding company and does not conduct regular banking operations, its primarysources of liquidity are dividends from the Bank. Under the CaliforniaFinancial Code, payment of a dividend from the Bank to the Company isrestricted to the lesser of the Bank’s retained earnings or the amount of theBank’s undistributed net profits from the previous three fiscal years. Theprimary uses of funds for the Company are stockholder dividends, investment inthe Bank and ordinary operating expenses. Management anticipates that there will be sufficient earnings at theBank level to provide dividends to the Company to meet its funding requirementsfor the foreseeable future.

 

Maintenance of adequateliquidity requires that sufficient resources be available at all time to meetour cash flow requirements. Liquidity in a banking institution is requiredprimarily to provide for deposit withdrawals and the credit needs of itscustomers and to take advantage of investment opportunities as they arise.Liquidity management involves our ability to convert assets into cash or cashequivalents without incurring significant loss, and to raise cash or maintainfunds without incurring excessive additional cost. For this purpose, wemaintain a portion of our funds in cash and cash equivalents, salablegovernment guaranteed loans and securities available for sale. We obtain fundsfrom the repayment and maturity of loans as well as deposit inflows, investmentsecurity maturities and paydowns, Federal funds purchased, FHLB advances, andother borrowings.  Our primary uses offunds are the origination of loans, the purchase of investment securities,withdrawals of deposits, maturity of certificate of deposits, repayment ofborrowings and dividends to common and preferred stockholders. Our liquidassets at September 30, 2009 were $76.0 million compared to $60.9 millionat December 31, 2008.  Our liquidity level measured as the percentageof liquid assets to total assets was 14.5% and 12.0% at September 30, 2009and December 31, 2008, respectively. We anticipate that cash and cashequivalents on hand and other sources of funds will provide adequate liquidityfor our operating, investing and financing needs and our regulatory liquidityrequirements for the foreseeable future. Management monitors our liquidityposition daily, balancing loan funding/payments with changes in depositactivity and overnight investments.

 

As a secondary source ofliquidity, we rely on advances from the FHLB to supplement our supply oflendable funds and to meet deposit withdrawal requirements. Advances from theFHLB are typically secured by a portion of our loan portfolio. The FHLBdetermines limitations on the amount of advances by assigning a percentage toeach eligible loan category that will count towards the borrowing capacity. Asof September 30, 2009, our borrowing capacity from the FHLB wasapproximately $119.9 million and the

outstanding balance was$27.0 million, or approximately 22.5% of our borrowing capacity. We alsomaintain 2 lines of credit with correspondent banks to purchase up to$20 million in federal funds, for which there were no advances as of September 30,2009.

 

**Off-Balance-SheetArrangements**

 

During the ordinarycourse of business, we provide various forms of credit lines to meet thefinancing needs of our customers. These commitments, which represent a creditrisk to us, are not represented in any form on our balance sheets.

 

As of September 30,2009 and December 31, 2008, we had commitments to extend credit of $64.2million and $63.1 million, respectively, which includes obligations underletters of credit of $2.3 million and $3.5 million, respectively.

 

The effect on ourrevenues, expenses, cash flows and liquidity from the unused portion of thecommitments to provide credit cannot be reasonably predicted because there isno guarantee that the lines of credit will be used.

 

**RecentLegislation and Other Regulatory Initiatives**

 

On February 17,2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) went intoeffect and amended certain provisions of the Emergency Economic StabilizationAct of 2008 (“EESA”), including replacing Section 111 of EESA in itsentirety.  The new Section 111 allows a participant in the TARP —Capital Purchase Program (“TARP-CPP”), such as the Company, to repay anyassistance previously received pursuant to the TARP-CPP without regard to thesource of replacement funds or any waiting period subject to consultation withthe appropriate Federal banking agency.  In addition, the new Section 111set forth in ARRA includes standards and requirements regarding executivecompensation and corporate governance.  On June 10, 2009,Treasury issued an interim final rule implementing and providing guidanceon the executive compensation and corporate governance provisions of EESA, asamended by ARRA. The regulations were published in the Federal Register on June 15,2009.  In addition, on July 1, 2009, the SEC 

 

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published a proposedamendment to the proxy rules which would implement the ARRA’s requirementthat TARP-CPP participants provide a separate shareholder vote to approve thecompensation of the company’s executives.  Together, the Treasury’sinterim final rule and the SEC’s proposed rule do (or would, in thecase of the SEC’s proposed rule) impose:

 

·                  Limits on compensation that exclude incentives for theCompany’s Senior Executive Officers to take unnecessary and excessive risksthat threaten the value of the Company;

 

·                  A provision for the recovery of any bonus, retentionaward, or incentive compensation paid to the Company’s Senior ExecutiveOfficers or to any of the Company’s next twenty most highly compensatedemployees based on certain financial statements or other criteria that arelater found to be materially inaccurate;

 

·                  A prohibition on the Company from making any paymentsto the Senior Executive Officers or to any of the next five most highlycompensated employees for departure from the Company for any reason, except forpayments for services performed or benefits accrued;

 

·                  A prohibition on the Company’s ability to pay bonusesand certain other compensation to the Company’s Chief Executive Officer, exceptwith respect to certain restricted stock awards or to the extent that a bonusis required by a valid employment contract;

 

·                  A prohibition on any compensation plan that wouldencourage manipulation of the Company’s reported earnings for the purposes ofenhancing employee compensation;

 

·                  A requirement for the Company’s Chief ExecutiveOfficer and Chief Financial Officer to provide certain certifications regardingthe foregoing;

 

·                  Certain requirements with respect to the Company’sPersonnel and Compensation Committee;

 

·                  A requirement to adopt a company-wide policy regardingexcessive or luxury expenditures;

 

·                  A requirement to permit a nonbinding “say on pay”shareholder vote to be included in the Company’s proxy statement with respectto an annual meeting of stockholders; and

 

·                  Authorizing the Secretary of the Treasury to reviewcertain compensation paid to the Company’s Senior Executive Officers and thenext 20 most highly-compensated employees to determine whether any suchpayments were inconsistent with the purposes of the foregoing.

 

In light of the Treasury’sinterim final rule and the SEC’s proposed rule, the Company intendsto evaluate and amend any employment agreements, benefit plans and otherarrangements, and take any other action necessary to ensure compliance with theapplicable requirements.

 

The actions describedabove, together with additional actions announced by the Treasury and otherregulatory agencies continue to develop.  It is not clear at thistime what impact EESA, ARRA, TARP, the Treasury’s interim final rule andthe SEC’s proposed rule and other liquidity and funding initiatives of theTreasury and other bank regulatory agencies that have been previouslyannounced, and any additional programs that may be initiated in the future willhave on the financial markets and the financial servicesindustry.  The extreme levels of volatility and limited creditavailability currently being experienced could continue to effect the U.S.banking industry and the broader U.S. and global economies, which will have anaffect on all financial institutions, including the Company.  Wecannot predict the full effect that this wide-ranging legislation will have onthe national economy or on financial institutions.

 

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**Item 3.****                                                                              ****Quantitative andQualitative Disclosures About Market Risk**

 

Not applicable.

 

 

**Item 4T.****                                                                      ****Controls and Procedures**

 

The Company’s ChiefExecutive Officer and its Chief Financial Officer, after evaluating theeffectiveness of the Company’s disclosure controls and procedures, as definedin Exchange Act Rules 13 a-15(e)and 15(d)-15(e) promulgatedunder the Exchange Act, as of the end of the period covered by this report (the“Evaluation Date”) have concluded that as of the Evaluation Date, the Company’sdisclosure controls and procedures were adequate and effective to ensure thatmaterial information relating to the Company would be made known to them byothers within the Company, particularly during the period in which this reportwas being prepared.  Disclosure controls and procedures are designed toensure that information required to be disclosed by us in the reports that wefile or submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.  Disclosure controls and proceduresinclude, without limitation, controls and procedures designed to ensure thatinformation required to be disclosed by us in the reports that we file underthe Exchange Act is accumulated and communicated to our management, includingour Chief Executive Officer and Chief Financial Officer, as appropriate toallow timely decisions regarding required disclosure.

 

There were no significantchange in the our internal control over financial reporting during the lastfiscal quarter that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting subsequent tothe Evaluation Date, nor there were any significant deficiencies or materialweaknesses in such controls requiring corrective actions.

 

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**PART II - OTHER INFORMATION**

 

**Item 1.****                                                                              ****Legal  Proceedings**

 

There are no pending, orto management’s knowledge, any threatened, material legal proceedings to whichwe are a defendant, or to which any of our properties are subject.  There are no material legal proceedings towhich any director, any nominee for election as a director, any executive officer,or any associate of any such director, nominee or officer is a party adverse tous.

 

 

**Item 1A.****                                                                     ****Risk Factors**

 

Not applicable.

 

**Item 2.****                                                                              ****Unregistered Sales ofEquity Securities and Use of Proceeds**

 

We did not have anyunregistered sales of our equity securities during the three months ended September 30,2009.

 

**Item 3.****                                                                              ****Defaults Upon SeniorSecurities**

 

None.

 

**Item 4.****                                                                              ****Submission of Matters toa Vote of Security Holders**

 

None

 

**Item 5.****                                                                              ****Other Information**

 

None.

 

**Item 6.****                                                                              ****Exhibits**

 

The  following exhibits are filed as part of thisreport or hereby incorporated by reference to filings previously made with theSEC:

 
| 3.1   |   | Articles of Incorporation  (incorporated by reference to Exhibit 3.1 to the Company’s Registration  Statement on Form 10-12B filed with the Securities and Exchange  Commission on July 31, 2008).                                                                                                                        |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2   |   | First Amendment to Articles of  Incorporation (incorporated by reference to Exhibit 3.2 to the Company’s  Registration Statement on Form 10-12B filed with the Securities and  Exchange Commission on July 31, 2008).                                                                                                     |
| 3.3   |   | Bylaws (incorporated by  reference to Exhibit 3.3 to the Company’s Registration Statement on  Form 10-12B filed with the Securities and Exchange Commission on  July 31, 2008).                                                                                                                                           |
| 3.4   |   | Certificate of Amendment of  Bylaws (incorporated by reference to Exhibit 3.5 to the Company’s  Registration Statement on Form 8-A12B filed with the Securities and  Exchange Commission on January 14, 2009).                                                                                                            |
| 4.1   |   | Certificate of Determination  filed with the California Secretary of State for Fixed Rate Cumulative  Perpetual Preferred Stock, Series A (incorporated by reference to  Exhibit 3.4 to the Company’s Registration Statement on Form 8-A12B  filed with the Securities and Exchange Commission on January 14, 2009). |
| 4.2   |   | Warrant to Purchase Common  Stock dated December 5, 2008 (incorporated by reference to  Exhibit 3.4 to the Company’s Registration Statement on Form 8-A12B  filed with the Securities and Exchange Commission on January 14, 2009).                                                                                  |
| 31.01 |   | Certification of Principal  Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                      |
| 31.02 |   | Certification of Principal  Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                      |
| 32.01 |   | Certification pursuant to 18  U.S.C. Section 1350 as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                            |

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, as amended, the registranthas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.

 
| ** **                    | ** ** | **Oak  Valley Bancorp** |
|-------------------------------|------------|-------------------------|
| Date: November 13,  2009 |       | By:                     | /s/    RICHARD  A. MCCARTY |
| ** **                    | ** ** | ** **              | **Richard  A. McCarty** |
| ** **                    | ** ** | ** **              | **Executive  Vice President and Chief Financial Officer** |
| ** **                    | ** ** | ** **              | **(Principal  Financial Officer and duly authorized****signatory)** |

 

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**EXHIBITINDEX**

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                             |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **  | ** ** | ** **                                                                                                                                                                                  |
| 31.01       |       | Certification of Chief  Executive Officer pursuant to Exchange Act Rules 13a-14(a) and  15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act  of 2003     |
| 31.02       |       | Certification of Chief  Financial Officer pursuant to Exchange Act Rules 13a-14(a) and  15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act  of 2003     |
| 32.01       |       | Certifications of Chief  Executive Officer and Chief Financial Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2003 |

 

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